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Roth IRAs: The Complete Guide
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What Is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) that allows qualified withdrawals on a tax-free basis provided certain conditions are satisfied. Established in 1997, it was named after William Roth, a former Delaware Senator.

Roth IRAs are similar to traditional IRAs, with the biggest distinction between the two being how they’re taxed. Roth IRAs are funded with after-tax dollars; this means the contributions are not tax-deductible. But once you start withdrawing funds, the money is tax-free. Conversely, traditional IRA deposits are generally made with pre-tax dollars; you usually get a tax deduction on your contribution and pay income tax when you withdraw the money from the account during retirement.

This and other key differences make Roth IRAs a better choice than traditional IRAs for some retirement savers.

Key Takeaways

  • A Roth IRA is a special retirement account where you pay taxes on money going into your account, and then all future withdrawals are tax-free.
  • Roth IRAs are best when you think your marginal taxes will be higher in retirement than they are right now.
  • You can't contribute to a Roth IRA if you make too much money. In 2021, the limit for singles is $140,000, (In 2022, the limit is $144,000). For married couples filing jointly, the limit is $208,000 ($214,000 in 2022).
  • The deductible amount you can contribute changes periodically. In 2021 and 2022, the contribution limit is $6,000 a year unless you are age 50 or older—in which case, you can deposit up to $7,000.
  • Almost all brokerage firms, both physical and online, offer a Roth IRA. So do most banks and investment companies.

Understanding Roth IRAs

Similar to other qualified retirement plan accounts, the money invested within the Roth IRA grows tax-free. However, a Roth is less restrictive than other accounts. The account holder can maintain the Roth IRA indefinitely; there are no required minimum distributions (RMDs) during their lifetime, as there are with 401(k)s and traditional IRAs.

A Roth IRA can be funded from a number of sources:

  • Regular contributions
  • Spousal IRA contributions
  • Transfers
  • Rollover contributions
  • Conversions

All regular Roth IRA contributions must be made in cash (which includes checks ad money orders); they can't be in the form of securities or property. However, a variety of investment options exist within a Roth IRA once the funds are contributed, including mutual funds, stocks, bonds, ETFs, CDs, and money market funds.

The IRS limits how much can be deposited in any type of IRA, adjusting the amounts periodically. The contribution limits are the same for traditional and Roth IRAs.


The maximum annual contribution an individual can make to a Roth IRA in 2021 remains the same in 2022. Those 50 years old and up can contribute up to $7,000.

Opening a Roth IRA

A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. These include banks, brokerage companies, federally insured credit unions, and savings and loan associations. Generally, individuals open IRAs with brokers.

A Roth IRA can be established at any time. However, contributions for a tax year must be made by the IRA owner’s tax-filing deadline, which is generally April 15 of the following year. Tax-filing extensions do not apply.

On March 17, 2021, the Internal Revenue Service (IRS) announced that the federal income tax filing due date for all taxpayers for the 2020 tax year was automatically extended from April 15, 2021, to May 17, 2021. That pushed other tax-related deadlines back as well; for example, the deadline to make IRA contributions is usually April 15, but taxpayers had extra time this year.

Taxpayers impacted by the 2021 winter storms in Texas had until June 15, 2021, to file various individual and business tax returns, make tax payments, and make 2020 IRA contributions. (The IRS's extension for victims of the 2021 winter storms was announced on Feb. 22, 2021.)

There are two basic documents that must be provided to the IRA owner when an IRA is established:

These provide an explanation of the rules and regulations under which the Roth IRA must operate, and establish an agreement between the IRA owner and the IRA custodian/trustee.

Not all financial institutions are created equal. Some IRA providers have an expansive list of investment options, while others are more restrictive. Almost every institution has a different fee structure for your Roth IRA, which can have a significant impact on your investment returns.

Your risk tolerance and investment preferences are going to play a role in choosing a Roth IRA provider. If you plan on being an active investor and making lots of trades, you want to find a provider that has lower trading costs. Certain providers even charge you an account inactivity fee if you leave your investments alone for too long. Some providers have more diverse stock or exchange traded fund offerings than others; it all depends on the type of investments you want in your account.

Pay attention to the specific account requirements as well. Some providers have higher minimum account balances than others. If you plan on banking with the same institution, see if your Roth IRA account comes with additional banking products. If you're looking at opening a Roth at a bank or brokerage where you already have an account, see whether existing customers receive any IRA fee discounts.


Roth IRA Vs. Traditional IRA

Are Roth IRAs Insured?

If your account is located at a bank, be aware IRAs fall under a different insurance category than conventional deposit accounts. Therefore, coverage for IRA accounts is not as robust. The Federal Deposit Insurance Corporation (FDIC) still offers insurance protection up to $250,000 for traditional or Roth IRA accounts, but account balances are combined rather than viewed individually.

For example, if the same banking customer has a certificate of deposit held within a traditional IRA with a value of $200,000 and a Roth IRA held in a savings account with a value of $100,000 at the same institution, the account holder has $50,000 of vulnerable assets without FDIC coverage.

What Can You Contribute to a Roth IRA?

The IRS dictates not only how much money you can deposit in a Roth, but the type of money you can deposit. Basically, you can only contribute earned income to a Roth IRA.

For individuals working for an employer, compensation that is eligible to fund a Roth IRA includes wages, salaries, commissions, bonuses, and other amounts paid to the individual for the services they perform. It's generally any amount shown in Box 1 of the individual's Form W-2. For a self-employed individual or a partner or member of a pass-through business, compensation is the individual’s net earnings from their business, less any deduction allowed for contributions made to retirement plans on the individual’s behalf and further reduced by 50% of the individual’s self-employment taxes.

Money related to divorce—alimony, child support, or in a settlement—can also be contributed if it is related to taxable alimony received from a divorce settlement executed prior to December 31, 2018.

So what sort of funds aren't eligible? The list includes:

  • Rental income or other profits from property maintenance
  • Interest income
  • Pension or annuity income
  • Stock dividends and capital gains
  • Passive income earned from a partnership in which you do not provide substantial services

You can never contribute more to your IRA than your earned income in that tax year. And, as previously mentioned, you receive no tax deduction for the contribution—although you may be able to take a Saver's Tax Credit of 10%, 20%, or 50% of the deposit, depending on your income and life situation.

Who's Eligible for a Roth IRA?

Anyone who has earned income can contribute to a Roth IRA—as long as they meet certain requirements concerning filing status and modified adjusted gross income (MAGI). Those whose annual income is above a certain amount, which the IRS adjusts periodically, become ineligible to contribute. The chart below shows the figures for 2021 and 2022.

Do You Qualify for a Roth?
Category Income Range for 2021 Contribution Income Range for 2022 Contribution
Married and filing a joint tax return Full: Less than $198,000 Partial: From $198,000 to less than $208,000 Full: Less than $204,000 Partial: From $204,000 to less than $214,000
Married, filing a separate tax return, lived with spouse at any time during the year Full: $0 Partial: Less than $10,000 Full: $0 Partial: Less than $10,000
Single, head of household, or married filing separately without living with spouse at any time during the year Full: Less than $125,000 Partial: From $125,000 to less than $140,000 Full: Less than $129,000 Partial: From $129,000 to less than $144,000

Here's how the system works: An individual who earns less than the ranges shown for their appropriate category can contribute up to 100% of their compensation or the contribution limit, whichever is less. 

Individuals within the phase-out range must subtract their income from the maximum level and then divide that by the phase-out range to determine the percentage of $6,000 they are allowed to contribute.

The Spousal Roth IRA

One way a couple can boost their contributions: the spousal Roth IRA. An individual may fund a Roth IRA on behalf of their married partner who earns little or no income. Spousal Roth IRA contributions are subject to the same rules and limits as regular Roth IRA contributions. The spousal Roth IRA is held separately from the Roth IRA of the individual making the contribution, as Roth IRAs cannot be joint accounts.

For an individual to be eligible to make a spousal Roth IRA contribution, the following requirements must be met:

  • The couple must be married and file a joint tax return.
  • The individual making the spousal Roth IRA contribution must have eligible compensation.
  • The total contribution for both spouses must not exceed the taxable compensation reported on their joint tax return.
  • Contributions to one Roth IRA cannot exceed the contribution limits for one IRA (however, the two accounts allow the family to double their annual savings).

Withdrawals: Qualified Distributions

At any time, you may withdraw contributions from your Roth IRA, both tax- and penalty-free. If you take out only an amount equal to the sum you've put in, the distribution is not considered taxable income and is not subject to penalty, regardless of your age or how long it has been in the account.

However, there's a catch when it comes to withdrawing account earnings—any returns the account has generated. For distribution of account earnings to be considered a qualified distribution, it must occur at least five years after the Roth IRA owner established and funded his/her first Roth IRA, and the distribution must occur under at least one of the following conditions:

  • The Roth IRA holder is at least age 59½ when the distribution occurs.
  • The distributed assets are used toward the purchase—or to build or rebuild—a first home for the Roth IRA holder or a qualified family member (the IRA owner's spouse, a child of the IRA owner or of the IRA owner's spouse, a grandchild of the IRA owner and/or of their spouse, a parent or other ancestor of the IRA owner or of their spouse). This is limited to $10,000 per lifetime.
  • The distribution occurs after the Roth IRA holder becomes disabled.
  • The assets are distributed to the beneficiary of the Roth IRA holder after the Roth IRA holder's death.

The 5-Year Rule

Withdrawal of earnings may be subject to taxes and/or a 10% penalty, depending on your age and whether you've met the 5-year rule. Here's a quick rundown.

If you meet the 5-year rule:

  • Under 59½: Earnings are subject to taxes and penalties. You may be able to avoid taxes and penalties if you use the money for a first-time home purchase (a $10,000-lifetime limit applies), if you have a permanent disability, or if you pass away and your beneficiary takes the distribution. 
  • Age 59½ and older: No taxes or penalties. 

If you don’t meet the 5-year rule:

  • Under 59½: Earnings are subject to taxes and penalties. You may be able to avoid the penalty (but not the taxes) if you use the money for a first-time home purchase (a $10,000-lifetime limit applies), qualified education expenses, unreimbursed medical expenses, if you have a permanent disability, or if you pass away (and your beneficiary takes the distribution). 
  • 59½ and older: Earnings are subject to taxes but not penalties.

Roth withdrawals are made on a FIFO basis (first in, first out)—so any withdrawals made come from contributions first. Therefore, no earnings are considered touched until all contributions have been taken out.

Withdrawals: Non-Qualified Distributions

A withdrawal of earnings that do not meet the above requirements is considered a non-qualified distribution and may be subject to income tax and/or a 10% early-distribution penalty. There may be exceptions, however, if the funds are used:

  • For unreimbursed medical expenses. If the distribution is used to pay unreimbursed medical expenses for amounts that exceed 10% of the individual's adjusted gross income (AGI) for 2021 (or 7.5% for recent tax years prior to 2021).
  • To pay medical insurance. If the individual has lost his or her job.
  • For qualified higher-education expenses. If the distribution goes toward qualified higher-education expenses of the Roth IRA owner and/or his or her dependents. These qualified education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution and must be used in the year of the withdrawal.
  • For childbirth or adoption expenses. Up to $5,000, if made within one year of the event.

Note that if you withdraw only the amount of your contributions made within the current tax year—including any earnings on those contributions—the contribution is reversed. For example, If you contribute $5,000 in the current year and those funds generate $500 in earnings, you can withdraw the $5,000 principal tax-free and penalty-free and the $500 gain will be treated as taxable income.

Coronavirus-Related Distributions

A special provision in the Coronavirus Aid, Relief, and Economic Security (CARES) Act allowed taxpayers to take a coronavirus-related distribution between Jan. 1, 2020, and Dec. 31, 2020, up to an aggregate $100,000 from all qualified plans and IRAs. The coronavirus-related distribution could be taken by a qualified individual, defined by the IRS as someone who was negatively affected by the coronavirus—either financially or through a family diagnosis. Retirement plan owners who qualified for coronavirus-related distributions included those:

  • Diagnosed with SARS-CoV-2
  • Whose spouse or dependent was diagnosed with SARS-CoV-2
  • Who were financially impacted due to furlough, quarantine, layoff, or reduced work hours during the pandemic
  • Who were unable to work due to lack of childcare during the pandemic
  • Who were financially impacted due to the reduction of business hours or closure of their own business during the pandemic

The special provision allows the retirement account holder to take the distribution as a standard withdrawal, with no repayment, or as a loan with a repayment option. The distribution was exempt from the 10% early-distribution penalty, but it was taxed as ordinary income. The CARES Act allows the withdrawal to be taxed as ordinary income in full in 2020 or over a three-year period in 2020, 2021, and 2022. If you plan to pay back the funds, you have until the end of the third year. Please note, you will still have to pay taxes on the distribution until the year you pay it back.

For example, let's assume you withdrew $15,000 in 2020. You would need to claim $5,000 on your tax returns in 2020 and 2021. If you repay the funds in full in 2022, you would not need to pay taxes on the final $5,000. Additionally, you will need to file an amended return for 2020 and 2021 to recoup your taxes previously paid on the first two-thirds.

If you have multiple retirement accounts, the Roth IRA may have been the best option to take a coronavirus-related distribution. For Roth IRAs, remember that withdrawals up to the amount of contributed funds are always tax-free since contributions are made on an after-tax basis. Because Roth withdrawals are taken on a First In, First Out (FIFO) basis, and no earnings are considered touched until all contributions have been taken out first, your taxable distribution would be even less from a Roth IRA.

Roth IRA vs. Traditional IRA

Whether or not a Roth IRA is more beneficial than a traditional IRA depends on the tax bracket of the filer, the expected tax rate at retirement, and personal preference.

Individuals who expect to be in a higher tax bracket once they retire may find the Roth IRA more advantageous since the total tax avoided in retirement will be greater than the income tax paid in the present. Therefore, younger and lower-income workers may benefit the most from a Roth IRA.

Indeed, by beginning to save with an IRA early in life, investors make the most of the snowballing effect of compound interest: Your investment and its earnings are reinvested and generate more earnings, which are reinvested, and so on.

Consider opening a Roth rather than a traditional IRA if you are more interested in tax-free income when you retire than in a tax deduction now when you contribute.

Of course, even if you expect to have a lower tax rate in retirement, you'll still enjoy a tax-free income stream from your Roth. Not the worst idea in the world.

Those who don't need their Roth IRA assets in retirement can leave the money to accrue indefinitely and pass the assets to heirs tax-free upon death. Even better, while the beneficiary must take distributions from an inherited IRA, they can stretch out tax deferral by taking distributions for a decade and, in some specialized cases, for their lifetimes. Traditional IRA beneficiaries, on the other hand, do pay taxes on the distributions. Also, a spouse can roll over an inherited IRA into a new account and not have to begin taking distributions until age 72.

Some open or convert to Roth IRAs because they fear an increase in taxes in the future, and this account allows them to lock in the current tax rates on the balance of their conversions. Executives and other highly compensated employees who are able to contribute to a Roth retirement plan through their employers [for example, via a Roth 401(k)] can also roll these plans into Roth IRAs with no tax consequence and then escape having to take mandatory minimum distributions when they turn 72.

Is It Better to Invest in a Roth IRA or a 401(k)?

There are many variables to consider when choosing a Roth IRA or a 401(k) retirement account. Each type of account provides an opportunity for savings to grow tax-free. Roth IRAs do not provide tax advantages when you make a deposit, but you can withdraw tax-free during retirement.

The reverse is true for 401(k)s. These type of accounts involve contributing a portion of your paycheck into a 401(k) prior to income tax deductions.

In terms of contribution limits, Roth IRAs are typically lower than 401(k)s. Additionally, 401(k)s allow employers to make matching contributions. On the flip side, 401k(s) often have higher fees, minimum distributions, and fewer investment options. 

How Much Can I Put In My Roth IRA Monthly?

In 2021 and 2022, the maximum annual contribution amount for a Roth IRA is $6,000, or $500 monthly for those under 50. This amount increases to $7,000 annually or roughly $583 monthly for individuals 50 or older. 

What Are the Advantages of a Roth IRA?

While Roth IRAs do not include an employer match, they do allow for a greater diversity of investment options. For individuals who anticipate they will be in a higher tax-bracket when they’re older, Roth IRAs can also provide a beneficial option. 

In Roth IRAs, you can withdraw your contributions (but not earnings) tax and penalty-free. Ultimately, you can manage how you want to invest your Roth IRA through setting up an account with a brokerage, bank, or qualified financial institution. 

What Are the Disadvantages of a Roth IRA?

Among the disadvantages of Roth IRAs is the fact that, unlike 401(k)s, they do not include an upfront tax break. Secondly, annual contribution limits are about a third of 401(k)s. For some high-income individuals, there are reduced or limited contribution amounts. Additionally, there is no automatic payroll deduction.

Article Sources

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