What is a Roth IRA?

Retirement planning is an essential task that must be undertaken by you as soon as you begin your career and should ideally start saving for retirement, regardless of the nature of your job or your income. The money you save for your retirement will help support you during your non-working years and allow you to live a life of dignity, comfort, and respect. Having a retirement fund enables you to cover your essential and non-essential expenses, medical costs, as well as ensure and provide financial security for your dependents and loved ones. If you wish to seek assistance and are open to receiving help when it comes to managing your finances, you can consult with a professional financial advisor who can guide you and offer financial advice to you. The advisor can also help design a financial plan for you that will empower you to reach your financial goals.

The Individual Retirement Account or the IRA is one of the most popular retirement accounts in the United States. An IRA can be of two kinds: a traditional IRA and a Roth IRA.

In this article, we will talk about how you can open a Roth IRA account, withdrawals, contributions, uses, and will help you understand what makes Roth IRA so special.

Table of Contents

A Roth IRA is a retirement account wherein you contribute after-tax dollars allowing you to make tax-free withdrawals in retirement as long as you meet certain qualifying criteria. To do so, you must hold the account for a minimum of five years and withdraw money after reaching 59.5 years of age. The contributions are not tax-deductible, and all qualified withdrawals are tax-free in nature; also doubling up as an excellent option if you expect to be in a higher tax bracket in retirement that you are in presently.

Each year Roth IRA contributions & limits are revised by the Internal Revenue Service or the IRS. As of 2022, you can contribute to a Roth IRA if you meet the following income criteria:

Single tax filers earning a modified adjusted gross income (MAGI) of $144,000 or less are eligible to open a Roth IRA.
Married taxpayers filing jointly earning a joint MAGI of less than $214,000 are eligible to open a Roth IRA

As of 2022, the annual contribution limits for a Roth IRA are:

Individuals under the age of 50 can contribute up to $6,000 annually. This has remained unchanged compared to 2021.
Individuals aged 50 or above can contribute an additional catch-up contribution of $1,000, bringing the total to $7,000 per annum.

How to open a Roth IRA

If you are thinking of opening a Roth IRA, you can follow the steps listed below:

Check your eligibility: First, you have to find out if you are eligible to invest in a Roth IRA account or not. If you are a single taxfiler, your MAGI should be between $129,000 to $144,000; for married taxpayers, your combined MAGI should be between $204,000 to $214,000. If you lie in these income brackets, you can move ahead to the next step.
Select a place to open your account: You have several options where you can open your Roth IRA account – bank, credit union, or with an online broker. Each option offers different benefits. If you open your account with a bank or credit union, you can invest in low risk and low return investments like certificates of deposits, money market accounts, etc. On the other hand, online brokers offer high-risk and high-reward investments like stocks, mutual funds, etc. You can choose any option based on your risk appetite and future goals.
Fill out the application form: Next, you have to fill up an application form detailing your name, bank account information, Social Security number, the name and address of your employer, the name, address, and Social Security number of your beneficiaries, etc. Along with this you also need to file an IRS form: 5305-R.
Pick your investments: Choosing which investments to invest in is extremely important and plays a critical role in meeting your future goals and financial needs. Pick your investments based on your risk tolerance levels and if you have doubts over how to move forward, consult with a financial advisor who can help you with the same.
Choose how frequently you wish to contribute: Pick a frequency for your contributions. You can make contributions either monthly or yearly based on your preference.

What is the difference between Roth IRA and Traditional IRA?

Let us discuss the differences between a Roth and a traditional IRA in detail:

In a Roth IRA, you make contributions from your after-tax dollars, and the subsequent withdrawals are tax-free (dependent on meeting certain conditions explained above). On the other hand, in a traditional IRA, contributions are made from your pre-tax dollars, and your withdrawals are taxed in retirement.
If you have chosen a traditional IRA, your contributions are tax-deferred whereas in a Roth IRA your contributions grow tax-free. If you wish to save taxes in the present, you can opt for a traditional IRA, however, if you believe you would be in a higher tax bracket in retirement, you should go for a Roth IRA as it would be more beneficial for you in the long run.
Moreover, if you have invested in a traditional IRA, you do not have to adhere to any income limits. However, for a Roth IRA, your MAGI should be less than $144,000 or less as a single taxpayer and $214,000 as a married and joint taxpayer, to qualify for contributing to a Roth IRA.
Further, if you own a traditional IRA, you must take mandatory Required Minimum Distributions (RMDs) after the age of 72, failing to do so would result in hefty penalties and taxes. However, there are no mandatory RMDs for a Roth IRA.

What should you keep in mind before opening a Roth IRA?

Choosing between opening a traditional IRA or a Roth IRA account is an important decision that should not be taken lightly and without going over the ros and cons.

Let us discuss certain points that will offer you better clarity with respect to the efficacy of Roth IRA:

You have the option of converting your traditional IRA to a Roth IRA, though, you would have to pay taxes on your previous contributions and earnings. You can lower your taxes by opting for partial conversions.
You have the option to open up an IRA for your child as long as the child is earning income from a part-time job, be it from offering tuition, babysitting, waiting tables, etc. This kind of an IRA is known as a custodial IRA account which can help your child cover higher education costs or set up their own business at a later stage in life. By investing in a Roth IRA account, your savings grow over time rather than lying idly in a bank.
You can also open a spousal IRA who has the same contribution limits – $6,000 if you are below 50 years of age (or $7,000 for people aged 50 or older). You can open a spousal IRA even if your spouse does not earn any income. You can contribute on his/her behalf provided you have an earned income.
There is no set age limit for opening a Roth IRA account. Children can have a custodial Roth IRA. In addition, if you should choose to, you can keep contributing to your Roth account for as long as you want provided you do so from an earned income.
You can also pass on your Roth IRA to your beneficiaries. Any withdrawals made by them will also be tax-free, provided the 5-year holding period for the account was completed.
You are not allowed to take out a loan from your Roth IRA but you do have the option to withdraw funds for a 60-day period, known as a tax-free rollover. Herein, you must deposit the money back within the stipulated time. You can do one such tax-free rollover once a year.
The following kinds of incomes cannot be contributed to a Roth IRA:
- Rental income
- Interest income, capital gains, and stock dividends
- Pension
- Annuity income
Finally, you cannot contribute more than you earn in a financial year in a Roth IRA account.

Let us go through some FAQs that will shed some light on lesser known facts about a Roth IRA.

Frequently Asked Questions:

1. What is a spousal Roth IRA?

A spousal Roth IRA is a retirement account wherein you can make contributions on behalf of your spouse provided you do so from an earned income. It is a separate account which you can open and provide for your spouse’s financial security.

2. Can you suffer a monetary loss in a Roth IRA?

Yes, due to certain factors such as market fluctuations, penalties for early withdrawals, or not giving your money enough time to compound can result in a loss in a Roth IRA. If you have a low risk tolerance, you can choose low risk investments for your portfolio.

3. What are some of the downsides of a Roth IRA?

If you are looking to invest in a Roth IRA, you need to consider low annual contribution limits and delayed tax benefits before you decide on opening a Roth IRA account. Moreover, you cannot avail a loan facility from your Roth IRA, which is not the case if you invest in a traditional 401(k) account, which does offer a loan facility to its investors. Further, if you make an early withdrawal before reaching 59.5 years of age or completing a five year holding period, you would have to pay a 10% penalty in most cases.

4. Is a Roth IRA suitable for people with less income?

A Roth IRA can be used by people belonging to different income groups and income brackets. You can make contributions to a Roth IRA as long as you have an earned income.

5. Which is the better retirement plan to invest in – a Roth IRA or a 401k account?

Both retirement plans have their pros and cons. Your financial needs and goals are a better determinant of which retirement plan would be the right one for you. While a Roth IRA offers better investment options and can be used by people who do not have an employer plan like the 401(k), as well as people who already have a 401(k) and want to invest more money to create a substantial retirement corpus. Alternatively, a 401(k) enables you to save more money for retirement since its annual contributions are higher than a Roth IRA. Further, you need to take out mandatory RMDs in a 401(k) while there is no such rule for a Roth IRA. Be sure to take into account all the benefits and drawbacks of both these retirement accounts before making a decision.

6. How much money should I contribute monthly to my Roth IRA?

Contribute as per your goals, income, and budget. Do note that the more money you save, the more you would have later on for your golden years. Maximize your contributions and meet the annual prevailing contribution limits.

7. Who should I start a Roth IRA with?

There are several options available to you where you can open a Roth IRA account – bank, a credit union, or with an online broker. Generally, a bank or a credit union would offer low risk investments such as a certificate of deposit or a money market account as an investment option. Alternatively, online brokers and investment firms offer high yield investments like stocks, mutual funds, etc. so, you can make a decision based on your risk appetite.

8. Can I open a Roth IRA at my bank?

Yes, you can open a Roth IRA account at your bank.

9. Can you open a Roth IRA without a job?

Yes, you can open a Roth IRA without a job, provided you have an alternative source of earned income. This can also include your spouse’s income.

10. Why should I open a Roth IRA at a credit union?

Credit unions can offer lower fees and help you reduce costs. In addition, credit unions offer low-yielding investment options such as certificates of deposit that can limit your future earnings.

11. At what age are you eligible to start a Roth IRA?

There is no age limit set for investing in a Roth IRA. If you are an adult and have an earned income, you can open a Roth IRA account. In the case of minors, you can open a Roth IRA for children below 18, however, only a parent or guardian can open it for them.

12. Do I have to report my Roth IRA on my tax return?

Since contributions are made from your after-tax dollars making them tax deductible in nature, you do not have to report them on your tax returns.

13. What is the 5 year rule for Roth IRA?

To make tax-free withdrawals, you would have to have held your Roth IRA account for at least a period of five years and be of 59.5 years of age.

14. Do I make too much for a Roth IRA?

To contribute to a Roth IRA, the IRS has mandated income limits that need to be met by the investors.

Only single tax filers earning a modified adjusted gross income (MAGI) of $144,000 or less along with married taxpayers filing jointly having a joint MAGI of $214,000 or lower are eligible to contribute to a Roth IRA in 2022.

15. Can I have multiple Roth IRAs?

There is no restriction on the number of IRAs that you can own. However, you can only contribute up to the total contribution limits. For 2022, you can contribute up to $6,000 per annum and $7,000 if you are 50 or older.

16. How do I avoid taxes on a Roth IRA conversion?

When you convert your traditional IRA to a Roth IRA, you will be liable to pay taxes on the previous contributions and your account’s earnings. You can lower the taxes by undertaking partial conversions over many years. However, you cannot avoid paying taxes altogether.

17. Can my wife open a Roth IRA if she does not have a job or runs a business?

Yes, you can open a spousal Roth IRA for your wife and contribute to her account from your earned income.

To conclude

A Roth IRA is a great financial instrument for folks looking to retire. Apart from being a great tax-saving tool, it is easy to set up and can also be used to secure the future of other members of your family, such as your spouse or children. Moreover, you can choose your investment options and invest either in low-risk investments or high-yielding investment vehicles to build considerable wealth over a period of time. However, to maximize your returns, you need to start investing from an early age and be consistent.

If you are wondering how to open a Roth IRA or which investments to choose, you can get in touch with a professional financial advisor in your area and get started. Use WiserAdvisor’s free advisor match tool, answer a few simple questions about yourself, and get matched with 1-3 financial advisors that help you with your retirement.