Roth IRA: Definition, Limits, Rules, & How to Open One

A Roth IRA retirement account offers tax-free withdrawals and investment gains. With low minimum investments, you can easily invest in stocks, funds, and fixed-income assets.

I highlight this account’s best benefits, annual contribution limits, and how to avoid early withdrawal penalties.

What is a Roth IRA?

A Roth IRA is a tax-advantaged individual retirement account (IRA) where your after-tax contributions grow tax-free.

Investing in stocks, funds, and fixed-income investments and making tax-free withdrawals after turning 59 ½ is possible. 

In contrast, a traditional IRA provides an upfront tax deduction as your contributions are tax-deferred and your distributions are tax-reportable.

How does a Roth IRA work?

Roth IRAs first became available to individual investors in 1998 after the passage of the Taxpayer Relief Act of 1997. This account derives its name from Delaware Senator William V. Roth Jr., a chief proponent of tax-free withdrawals in retirement.

While you won’t enjoy upfront tax benefits, this retirement account provides the peace of mind that your contributions and distributions are tax-free.

In most situations, your beneficiaries, such as a surviving spouse or children, also avoid paying taxes.

I specifically favor this account as you pay the income tax now instead of from your retirement income. Further, you hedge against potentially higher future tax rates as governments account for inflation and deficits.

Tax-friendly perks are just a start as there are multiple Roth IRA advantages:

• Not employer-linked: This isn’t a workplace retirement plan such as a 401(k) which not every employer offers. You may no longer be able to invest new money after terminating employment. 
• Flexible investment options: You can invest in stocks, bonds, funds, CDs, and alternative assets for a diversified retirement portfolio. The investment options can be better and less expensive than your 401(k) or similar retirement plans.
• No required minimum distributions (RMDs): Since you pay taxes during the contribution year, Roth IRAs do not require mandatory distributions as tax-deferred traditional IRAs require. You can quickly perform a 401(k) rollover to a Roth IRA.
• Can invest in 401(k) plans too: Employer-sponsored retirement plans are independent from IRAs meaning you can contribute to both for more retirement savings. Having a Roth IRA and a Roth 401(k) plus traditional tax-deferred accounts is possible.
• Have multiple Roth IRAs: Most online stock brokers and self-directed IRAs offer Roth IRAs. You can open and contribute to multiple IRAs yearly up to your annual contribution limit. Your spouse can have their own Roth IRA too.
• Competitive fees and minimums: Brokerage Roth IRAs through stock investing platforms like Fidelity, Vanguard, and Schwab usually don’t charge account maintenance fees or enforce minimum balances. Discount brokers are the most affordable. 

You can start making penalty-free withdrawals once your Roth IRA account is open for at least five years and you’re at least 59 ½ years old.

With few exceptions, early distributions are subject to a 10% penalty and your investment gains are tax-reportable. 

Ultimately, a Roth IRA is the best retirement account for tax-free investing.

You can contribute as long as you have earned income, even if you’re already retired.

What are the allowable investments for a Roth IRA?

Your Roth IRA account has similar investment options as a brokerage account:

• Mutual funds: This investment vehicle pools funds from investors to invest in individual stocks, bonds, and other assets. Index funds seek to passively match the performance of their benchmark and actively-managed funds strive to outperform. 
• Stocks: Own individual shares of domestic and international companies to earn dividends and have shareholder voting rights. This security is inherently more volatile and less diversified than mutual funds and ETFs.
• Bonds: Fixed-income investments receiving interest payments from corporate or government debt. 
• Exchange-traded funds (ETFs): Similar to mutual funds by investing in stocks, bonds, and other securities. The primary difference is that you can trade ETFs during the trading day while mutual fund transactions only process at the end of the trading day. 
• Certificates of deposits (CDs): A fixed-interest bank account during the investment term. CDs are available from banks, credit unions, and brokerages as a low-risk investment. 
• Money market funds: Available through stock brokerages, this mutual fund holds short-term debts, cash, and cash-like securities to earn compound interest.
• Precious metals: You can also open a self-directed gold IRA to own physical gold and silver stored at an IRS-approved depository. 

Your available investments differ by IRA provider.

Specifically, a full-service broker like Fidelity or Vanguard offers the whole gambit. However, a micro-investing app like M1 Finance only offers stocks and ETFs, or your bank’s IRA CD is exclusively for certificates of deposit.

Collectibles such as artwork, automobiles, stamps, and select precious metals are not IRA-eligible.

You may also want to speak with a financial advisor to optimize your tax-efficient investment strategy.

Roth IRA Contribution Limits

Your per-person annual IRA contribution limit mostly depends on your age, although high-income households may only qualify for a reduced amount.

You can contribute up to the annual contribution limit or your total earned income, whichever is lower.

Criteria	Contribution Limits (2024)
Under age 50	$7,000
Age 50 or older (catch-up contribution)	$8,000
Modified Adjusted Gross Income (MAGI) for tax filing status: Individual: > $146,000 but < $161,000  Joint: > $228,000 but < $240,000	Reduced amount
Modified AGI for tax filing status: Individual: > $161,000  Joint: > $240,000	None

IRA contribution limits usually change year-to-year depending on cost of living fluctuations.

Married spouses can contribute to their own IRA and double your annual household contribution limit.

That means your combined contributions can be up to $14,000 if you’re both under age 50 or $16,000 when each of you qualify for the $1,000 catch-up contribution.

If you happen to be a high-income earner, you can still be eligible for a “backdoor Roth IRA” when your modified AGI falls within the contribution phaseout bands. This savings option requires making non-deductible traditional IRA contributions you roll over to a Roth account.

Additionally, the annual IRA contribution limit is the combined threshold if you have multiple IRA accounts. For example, you must decide how much to contribute to a traditional or Roth IRA each year without exceeding $7,000 ($8,000 if 50 or older) in 2024.

The yearly Roth IRA contribution deadline is the federal tax filing deadline.

It’s April 15 in most years, while 401(k)s and similar workplace accounts have a December 31 contribution deadline.

Types of Roth IRAs

You can make Roth IRA contributions in several ways even when you don’t qualify for a standard account. 

Below is a Roth IRA definition for each specialty savings strategy:

• Spousal Roth IRA: Non-working spouses can contribute up to the annual contribution limit thanks to the Saver’s Credit when their partner earns income.  
• Backdoor Roth IRA: Workers who qualify for reduced or no direct Roth IRA contribution must first make non-deductible contributions to a traditional IRA. Next, you convert a traditional IRA to a Roth IRA through your online broker.  
• Mega Backdoor Roth IRA: Make after-tax contributions to a 401(k) or a similar workplace plan that has higher maximum contributions than a Roth IRA. When your plan provider offers this flexibility, you roll over the funds to a Roth IRA or a Roth 401(k). 
• Custodial Roth IRA: Children earning formal or self-employment income can open a Roth IRA for kids. The custodial account remains under the parent’s custody until the child reaches the age of majority between 18 and 21 years (varies by state).  

In addition to these, see if your employer offers a Roth 401(k) with higher contribution limits and can be eligible for employer-funded matching contributions.

You can invest in IRAs and 401(k)s simultaneously.

Pros & Cons

Here are the core benefits and disadvantages of using a Roth IRA account to save for retirement.

Pros

• Many investment options: Most online stock brokers and investment platforms offer this retirement account, which allows you to easily invest in stocks, bonds, funds, and alternative assets with tax-free dollars.
• Tax-free retirement income: Your investment gains and distributions are not subject to income taxes like tax-deferred traditional IRAs. As a result, your retirement plans can be more accurate as you remove the uncertainty of future tax rates.
• No mandatory distributions: You won’t encounter RMDs like tax-deferred accounts which can increase your withdrawal rate above your planned amount and risk outliving your savings. 
• Combines with other retirement accounts: You can also contribute to workplace retirement plans and health savings accounts (HSAs) with similar tax benefits. Your spouse can open their own account for more household retirement dollars.
• Low or no fees: Most Roth IRA providers don’t charge annual account maintenance fees and have low minimum investments, making it easy to start investing early. Many brokers waive trade commissions on stocks, ETFs, and mutual funds.

Cons

• Early distribution penalties: Your account must be open for at least five years before making penalty-free distributions, even if you’re at least 59 ½ years old. Consider a traditional IRA or a brokerage account to bypass the five-year rule.
• Income limits apply: High earners may not be able to make direct Roth contributions but can explore the backdoor Roth IRA strategy to increase their savings potential.
• No tax deductions: You can’t deduct your contributions to lower your contribution-year taxable income. Additionally, tax-free distributions may not be as beneficial as you initially anticipate when you retire in a lower tax bracket.

When can you withdraw from your Roth IRA?

Generally speaking, you can start withdrawing once you turn 59 ½ and your Roth IRA is at least five years old.

Otherwise, potential taxes and penalties on earnings but you can withdraw your original contributions tax-free and penalty-free at any time.

Over Age 59 ½ 

You won’t pay the 10% early withdrawal penalty as you’re age-eligible, but the five-year rule determines if taxes on withdrawn earnings are due:

• Initial funding was at least five years ago: No taxes or penalties as you satisfy the age and five-year holding requirements. 
• Less than five years ago: Taxes apply to earnings without the additional 10% penalty.

Consider investing through a traditional tax-deferred or taxable brokerage account if you anticipate withdrawals within the first five years.

Age 59 ½ or Younger

When you’re under age 59 ½, you will most likely pay taxes and penalties on your Roth IRA earnings as they have grown tax-free so far.

State taxes may also apply to discourage early withdrawals.

Your tax treatment depends on if you initially funded your account at least five years ago: 

• Initial funding was at least five years ago: You avoid taxes and penalties on a first-time home purchase (up to $10,000 lifetime maximum) or you become disabled or deceased.
• Less than five years ago: Taxes apply and the 10% additional penalty applies except for these IRS-approved exceptions:
  • First-time home purchase ($10,000 lifetime maximum)
  • Qualifying unreimbursed medical expenses
  • Select health insurance premiums after receiving unemployment benefits
  • Higher education expenses
  • Qualified birth or adoption expenses (up to $5,000)
  • Federally-qualified emergencies and disasters
  • Qualified reservist distributions
  • IRS levies
  • Corrective distributions
  • Total and permanent disability
  • Terminal illness
  • Death of an IRA owner
  • Substantially equal periodic payments 

Additionally, the Roth IRA five-year rule applies to Roth 401(k) rollovers for accounts previously older than a half-decade.

The five-year period restarts with the new account. I found this out the hard way with an unanticipated tax bill. 

You will receive a year-end 1099-R tax form for the distribution year to calculate your potential tax burden.

My tax preparer helped me report the distributions as I used some proceeds for a first-time home purchase.

Eligibility Requirement

Roth IRA eligibility hinges on your tax filing status and annual modified adjusted gross income (MAGI).

Tax Filing Status	Annual Income
Single, Head of Household, or Married, Filing Separately and not living with your spouse at any time during the year.	Full: Below $146,000 Partial: Between $146,000 and $161,000 None: $161,000 or more
Married Filing Jointly and Qualified Widow(er)	Full: Below $228,000  Partial: Between $228,000 and $240,000 None: $240,000 or more
Married, Filing Separately and lived with your spouse at any time during the year	Partial: Up to $10,000 None: $10,000 or more

These IRS guidelines provide more insights into calculating your eligibility if you earn a high income or have a unique tax situation.

Roth IRA vs. Traditional IRA

You can allocate your IRA contribution dollars to Roth and traditional IRA accounts each year. The better option depends on whether you want tax-free withdrawals in retirement or an upfront tax deduction.

Criteria	Roth IRA	401(k)
Most Unique Benefit	Tax-Free Withdrawals	High Contribution Limits
Investment Options	Stocks, bonds, mutual funds, ETFs, and CDs	Stocks, bonds, and mutual funds
Income Limits	Upper Limits Apply	None
Max Contributions	$7,000 ($8,000 if age 50 or older)	Employee: $23,000 Catch-up contributions: $7,500 Combined Employer and Employee: $69,000
Contributions	After-tax	After-tax (Roth) or pre-tax (traditional)
Withdrawals	Tax-free	Tax-free (Roth) or taxable (traditional)
Mandatory Distributions	None	Traditional: Age 73 Roth: None

How to open a Roth IRA Account

It only takes a few minutes to open your first Roth IRA:

1. Choose an online broker: Most full-service or discount brokers offer Roth IRAs. Be sure to compare investment options, account fees, and minimums.
2. Complete initial paperwork: The signup process is similar with every broker. You provide your personal contact information and Social Security number. You will also designate beneficiaries, such as your spouse or dependents.
3. Fund your Roth IRA: You can fund your IRA by transferring funds from a bank account, converting a traditional IRA, or by initiating a 401(k) rollover. 
4. Start Investing: Make your first investment once the funds become available during the next stock market trading session.

Should I invest with a Roth IRA?

A Roth IRA is the best retirement account for tax-free withdrawals, especially when your after-tax contributions have decades of tax-free growth.

Still, a traditional IRA is better when you prefer the upfront tax deduction or the five-year rule delays your planned withdrawal date.

FAQ’s