A Roth IRA is a terrific way to save for retirement. While you don’t get any upfront tax breaks, your contributions and earnings grow tax-free. And when you later take qualified distributions, they’re tax-free too. If you expect to be in a higher tax bracket in retirement than you are now or if you just don’t want to worry about any taxes, this vehicle can be a smart tax strategy.

Key Takeaways

  • If you're eligible for a Roth IRA, you can contribute up to $6,000 a year. If you’re 50 or older, you can make an additional $1,000 catch-up contribution.
  • You can open a Roth IRA at many financial institutions and arrange to fund it automatically.
  • You can also fund a Roth IRA by moving money into it from another retirement account.

Opening and Funding Your Roth IRA

Before you can fund a Roth IRA, you have to open an account. Nearly all financial institutions—including banks, mutual fund companies, and brokerage firms—offer Roth IRA accounts. For convenience sake, you might want to open your account at a financial institution you already do business with.

Before you apply, make sure you’re eligible for a Roth IRA. Roth IRAs have income phase-out ranges and maximum thresholds that can block some high-income earners from eligibility. Moreover, you may be eligible one year to make contributions but not the next due to your annual salary.

Income earners below the threshold levels will generally have no problem. In most cases, you can take care of the account application easily online. You will just need the following:

  • A driver’s license (or some other photo ID)
  • A Social Security number
  • Banking details for funding, including a routing number and account number
  • Details on beneficiaries

Once your application is approved, you can usually make your first contribution with cash, a check, or a bank transfer. To simplify matters, you can also arrange for future contributions to come regularly and automatically out of your checking account or other source through automation.

Fund It with a Roth IRA Conversion

Another way to fund a Roth IRA is to transfer money from an existing retirement account. This is known as a Roth IRA conversion. You can move money into your Roth IRA from these sources:

  • Traditional IRAs
  • Employer-sponsored 401(k) or 403(b) plans
  • Government 457(b) plans
  • SEP-IRAs
  • SIMPLE IRAs

Keep in mind that a Roth conversion is usually a taxable event. When you move money from a taxable retirement account (such as a traditional IRA) to a Roth, you’ll owe income taxes on the conversion amount. In general, it can be a good idea to save a conversion for a year when:

  • You earn too much to contribute to a Roth directly
  • You are expecting a prolonged higher tax bracket in future years
  • The taxable account you’re moving funds from has suffered losses (a lower balance means you’ll owe less tax at conversion time)

If you plan to fund your account through a Roth IRA conversion, remember that you will probably have to pay income taxes on that money.

Set It and Forget It

You have until the tax year’s filing deadline to contribute to your Roth IRA. For 2020, that’s April 15, 2020. But you don’t have to wait until then. You can add money to your account as early as Jan. 1 of the current tax year. Funding your account as early as possible means your money will have that much longer to grow, tax-free.

You can make one large contribution—at any point between Jan. 1 and mid-April of the following year—if you have the cash on hand to do so. For many people, however, it’s easier to make several smaller contributions throughout the year. If you do that, it’s wise to set up a Roth IRA contribution schedule. Decide if you want to contribute weekly, monthly, quarterly—whatever works best for you—and mark those dates on your calendar or set reminders. Of course, that can be a lot to keep track of. Fortunately, as mentioned earlier, you can arrange for automatic transfers from your bank so you don’t forget to invest. Check your Roth IRA provider's website for how to go about it.

No matter how you fund your Roth IRA, try to make it a habit, and start as early as possible. If you open a Roth IRA when you’re 20, for example, contribute $6,000 a year until age 65, and your account earns an average of 8% a year, you’ll have more than $2.5 million heading into retirement. And it will all be tax-free.

Roth IRA Advantages

Roth IRAs have other perks as well. Unlike traditional IRAs, you don't have to take any required minimum distributions during your lifetime. So if you don’t need the money for living expenses, you can just leave it in the account to grow. You can then pass your entire Roth IRA to your beneficiaries, providing them with years of tax-free growth and income.

There’s also no age limit for making contributions, as there is with traditional IRAs. As long as you have earned income, you can keep adding to the account, even if you’re 100 years old. You can't fund it with investment income.

The contribution limits may change periodically but they are not a part of the IRS’s annual inflation adjustments. Thus, for 2020, you can contribute up to $6,000 to a Roth IRA—or $7,000 if you’re age 50 or older—same as in 2019.

The IRS does have certain income requirements for Roth IRAs which can be important to follow for high-income earners. The income levels do change annually with inflation adjustments. For 2020, the IRS’s Roth IRA income phase-out ranges are as follows:

  • $124,000 to $139,000 for singles and heads of household
  • $196,000 to $206,000 for married couples filing jointly
  • The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000

With these phase-out ranges, contributors below the minimum threshold are allowed to contribute the full amount. Contributors within the threshold can only contribute a percentage of the contribution amount. Earners at or above the threshold cannot contribute at all.

The phase-out percentage is calculated by taking the earner’s income level subtracted by the maximum of the phase-out range and dividing by the entire range. This helps to keep a balance on savings for classes across the economy. The more an earner makes within the phase-out range, the less they can contribute. For example a single earner under 50 making $129,000 annually could contribute 67% of $6,000 [($139,000-$129,000)/$15,000]. A single earner under 50 making $138,000 could only contribute 7% [($139,000-$138,000)/$15,000].