Web Content Viewer

Actions

What Is a Roth IRA, and How Does it Work?

Nov 07, 2020 4 min read Beth Braverman

Key takeaways

  • A Roth IRA is a type of tax-advantaged retirement savings account.
  • You contribute after-tax dollars to a Roth, but the money grows tax-free—and so are withdrawals in retirement.
  • Roth IRAs give retirees flexibility with income and tax planning.

 

What is a Roth IRA?

A Roth IRA (individual retirement account) allows you to save for retirement while minimizing your future taxes. While you’ll have to pay income taxes now on money you put into a Roth IRA, the money you deposit will grow tax-free. After age 59½, any money you withdraw won’t be taxed—as long as you’ve had the account for at least five tax years.

After-tax contributions and the ability to make tax-free withdrawals differentiates Roth IRAs from traditional IRAs; with traditional accounts, deposits are tax deductible but withdrawals aren't. As a result, Roth IRAs are often a great resource for young savers or anyone who thinks their tax bracket will be higher in retirement.

Even if you’re not sure whether your tax bracket will increase, you still might want to open a Roth IRA if you qualify based on your income. Unlike most retirement accounts, Roth IRAs don’t require minimum withdrawals during retirement. This can be helpful if you’re hoping to minimize taxes once you're no longer working.

Roth IRAs offer flexibility before retirement, too. You can withdraw your contributions from your account at any time without paying income tax or a penalty. However, if you’re under age 59½, you’ll have to pay taxes on the account’s growth—and unless you use the money for qualified expenses Open in a new window, such as medical bills or college tuition, you'll face a tax penalty as well.

 

How do Roth IRAs work?

As long as you meet the income limits, you can contribute to a Roth IRA. And if you have one, you can contribute to a workplace retirement account, like a 401(k), at the same time. You can open a Roth IRA via most brokerages, online or in person.

Once you’ve made an initial deposit, you’ll need to choose investments. If you’re saving for retirement, it’s wise to buy a well-diversified mix of stocks and bonds that reflects your time until retirement and risk tolerance. You can also invest your money in a target-date fund, which automatically adjusts its stock and bond holdings to grow more conservative over time. (Just make sure the fund's strategy doesn't overlap with retirement investments you may already have elsewhere.) If you’re not sure where to invest, a financial professional can help you.

 

Roth IRA contributions and limits

In 2021, you can contribute up to $6,000 to a Roth IRA (or $7,000 if you'll be at least age 50 by year-end). A 25-year-old who opens a Roth IRA and maxes out their contributions this year and every year going forward would have more than $1 million in their account by the time they’re 66 years old.

Even so, If you’re single and earn $125,000 or more, the amount you can contribute is reduced; if you make more than $140,000, you’re ineligible for a Roth IRA entirely. For married couples, the reduced contribution takes effect if their combined income ranges from $198,000 to $208,000.

You can make contributions to your Roth IRA all at once or through multiple deposits over the course of the year. If you opt for the latter route, set up automatic contributions to ensure you’re putting money into the account on a regular basis. Keep in mind that contributions made through next year’s tax deadline count toward this year’s contribution.

 

 

What you can do next

If you think a tax-free retirement account is right for you, contact a financial professional to help you open a Roth IRA. Consider your goals when making investment choices, and set up direct deposit to make it easier to save.

Please consult your tax and legal advisors regarding your particular circumstances.

 

Footnotes

Beth Braverman is a freelance writer covering personal finance, parenting and careers. Her work has appeared in dozens of publications, including Consumer Reports, CNBC.com, and CNNMoney.com.

For Compliance Use Only:1028201-00001-00

If you secure tomorrow, you can enjoy today.

Help make sure your loved ones are protected if something happens to you, with Prudential Life Insurance.

Get a Free Quote

Web Content Viewer

Actions

Find What Interests You


Web Content Viewer

Actions

Web Content Viewer

Actions

Web Content Viewer

Actions