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What Is a Roth IRA? How to Get Started

Roth IRAs are retirement accounts that offer valuable tax benefits, including tax-free growth on your investments.

Arielle O'SheaJuly 19, 2019

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How does a Roth IRA work?

A Roth IRA is a retirement account that encourages you to save by offering you a tax benefit. Unlike with a traditional IRA, your contributions to a Roth IRA are not tax-deductible. But those contributions and your investment earnings grow tax-free, meaning there’s no tax on your Roth IRA withdrawals in retirement. With a traditional IRA, your withdrawals in retirement are taxed as income.

Like a traditional IRA, a Roth IRA is an account that holds your investments, rather than an investment itself. You open a Roth IRA at a brokerage or bank, then select what you want to invest in, such as mutual funds, stocks, bonds, exchange-traded funds (ETFs) or bank savings products. (For a long-term goal like retirement, we recommend investing in stocks and bonds because of their higher returns. That means opening your Roth at a brokerage or robo-advisor rather than at a bank.)

? Ready to begin??Learn how to open a Roth

What are the benefits of a Roth IRA?

The usual advice, and for good reason, is that Roth IRAs?are a great retirement-savings account if you expect your tax rate to be higher in the future. That’s because you pay income tax on your money before contributing it to the Roth, so if your tax rate is lower now, it makes sense to pay taxes now in return for tax-free growth on your investment earnings.

In other words, Roth IRAs are a smart savings tool for young people just starting out, because they’re likely to face higher income tax rates as they move along in their career. But even someone who is further along on the career path may like a Roth IRA, because these accounts provide tax-free income in retirement.

Here are other Roth IRA benefits to consider:

  • In 2019,?Roth IRAs allow for contributions of up to $6,000 per year — or $7,000 if you’re 50 or older — and you can use it in addition to a 401(k).?(Those limits?are up from?$5,500 and $6,500 in 2018.)

  • You can withdraw the money you contributed without tax or penalty at any time, with no restrictions, because you’ve already paid taxes on that money. You may, however, be taxed or penalized if you withdraw your investment earnings.

  • Once you hit 59? and have held the account for at least five years, you can take distributions, including earnings, from a Roth IRA without paying federal taxes.

  • You can use Roth IRA money to pay for qualified college expenses without an early distribution penalty, so you can use the account to supplement or as an alternative to a college savings account like a 529 plan. Keep in mind that only the penalty is waived — you may still owe income taxes on early distributions of earnings, even if for qualified college costs.

  • You can open a Roth IRA at any age, as long as you have earned income (you can’t contribute more than your earned income).

  • The account is not subject to the required minimum distributions typically required from a traditional IRA or 401(k) beginning at age 70?. This means you can use a Roth to pass money to your heirs.

roth ira

Are you eligible for a Roth IRA?

Here’s the one downside: You won’t be eligible for a Roth if you earn too much.

The amount you can contribute to a Roth IRA begins to?shrink at certain thresholds for modified adjusted gross income, and keeps?shrinking as income rises, until your ability to contribute is eliminated completely.

For more details on Roth IRA limits and the exceptions to them, see our IRA limits page.

One note for high earners: A backdoor Roth IRA strategy, which involves converting a traditional IRA into a Roth IRA, allows you to sidestep these income limits and fund a Roth anyway.

There’s another contribution limit to keep in mind: You can contribute to a Roth IRA only as much as your earned income ("taxable compensation" in IRS parlance) for the year. But there is an exception: For a married couple, if one spouse isn’t working for pay, that spouse can contribute to a spousal IRA, as long as that spouse’s contributions and the working spouse’s contributions, added together, don’t exceed the couple’s earned income for the year. Read more about spousal IRAs.

Where can you open a Roth IRA?

Most online brokers, banks and robo-advisors offer Roth IRAs. A good first step in the Roth IRA shopping process is deciding whether you want to take a hands-off approach to investing — in which case a robo-advisor and its automated investment process might be appealing — or a more active approach to choosing your investments, which might make a traditional broker more attractive. Because most banks offer access to savings vehicles (like CDs), rather than investments, they are generally not the best place to open an IRA, which should be geared toward long-term growth.

Two of NerdWallet’s highest-ranked providers for hands-off Roth IRA management are Wealthfront?and?Betterment. Robo-advisors?use computer algorithms to offer investment plans tailored to your goals and time horizon, all for a fraction of the cost of traditional investment advisors.

Two of NerdWallet’s top picks for conventional Roth IRA brokerages are TD Ameritrade and Merrill Edge. These brokers appear in NerdWallet’s rankings because of their low costs, large selection of mutual funds and no account minimums.

? Want the deep dive? Here are all of our top picks for the best Roth IRA accounts

More Roth IRA questions? We've got answers

Unlike a bank savings account, a Roth IRA doesn’t come with a fixed interest rate. How much money you earn in your Roth will depend on what you invest in. While it is possible to invest your Roth IRA in fixed-income vehicles, such as certificates of deposit, if your retirement is a decade or more away, we recommend investing a significant part of your Roth in the stock market. That’s because the stock market’s average return has historically been far higher than the returns on bonds, bank savings accounts and similar less-risky investments.

If you're wondering how to choose investments for your Roth IRA, check out our three stress-free ideas for investing. To see how small differences in returns add up over time, check out our Roth IRA calculator.

Roth IRAs and 401(k)s are both valuable retirement savings plans, and the good news is, you can contribute to both if you want.

No matter what, if your 401(k) offers an employer match, be sure to invest enough in the 401(k) to get the full match. That's free money you don't want to ignore.

Then the question is: How good is your 401(k)? If your workplace plan offers solid investment choices at a low cost — think mutual fund expense ratios of about 0.5% or less — then that’s a smart place to invest. If your 401(k) plan isn’t great — maybe it’s expensive, or the lineup of investments isn’t good — then it makes sense to max out a Roth IRA or a traditional IRA, because you’ll generally be able to find a wide range of low-cost investments at a broker. (Check out our list of top-rated brokers for Roth IRAs for some low-cost options.)

Another question is: Do you want to get a tax break now, or later? A 401(k) is like a traditional IRA: You put money in before paying taxes on it — you get your tax break upfront — and your money grows tax-deferred until retirement, at which point you pay income tax on your contributions and investment earnings when you pull the money out.

With a Roth IRA and a Roth 401(k), you put money in after having paid income tax on it, and then your money grows tax-free and comes out entirely tax-free in retirement, assuming you follow the rules. Here’s more on how to choose between an IRA and a 401(k).

The Roth IRA contribution limit in 2018 was $5,500, or $6,500 if age 50 or older. (In 2019, you can contribute up to $6,000, or $7,000 if 50 or older). But there is a deadline to contribute, and it's the tax filing deadline, which generally falls on April 15. That is, April 15, 2019 was the last day to contribute to a traditional or Roth IRA for 2018. (SEP IRAs are an exception: You can contribute all the way through mid-October if you file an extension.)

If you transfer your 401(k) money to a Roth IRA, you’ll likely owe income tax on the entire amount you move over — unless your money is in a Roth 401(k). Plus, moving a lump sum of pre-tax money into an after-tax account like that may bump you into a higher tax bracket, possibly leading to a higher-than-expected tax bill.

If you’re eager to move your 401(k) to an IRA, then consider a rollover IRA. A rollover IRA is a traditional IRA. Like a 401(k), traditional IRAs hold pre-tax money. If you roll your money over from a 401(k) to a traditional IRA, you won’t get a tax bill for the rollover, as long as you follow the rollover rules.

Depending on what you invest your Roth IRA money in, you may, at times, see the value of your account dip. That’s especially true if you invest in the stock market. But despite that volatility, investors who stick with stocks for the long haul are able to ride out the dips and watch their money grow at average returns exceeding just about any other investment.

The key is to make sure your investments are diversified. If that seems like a task you don’t want to deal with, then consider the benefits of a robo-advisor — it will pick a diversified portfolio for you.

There are many advantages to a Roth IRA, but nothing’s perfect. Here are a couple of disadvantages to consider:

--You can’t take a loan from an IRA the way you can with many 401(k)s. That said, you can always withdraw your Roth IRA contributions anytime without penalty, interest or taxes. --Early withdrawals (before age 59?) of your investment earnings come with a 10% penalty unless you meet one of a handful of exceptions.

Whether $1 million is enough for a comfortable retirement will depend on your lifestyle, location and life expectancy. Half of Americans (50%) believe $1 million is enough to retire on, while 31% say it would not be enough, according to a NerdWallet survey, conducted online by The Harris Poll, of more than 2,000 U.S. adults in June 2018. Nineteen percent are not sure if it is enough.

Overall, only 32% of Americans say they’re confident they’ll have enough money saved for retirement by their desired retirement age based on their current rate of savings. Making use of tax-advantaged retirement accounts — including workplace retirement plans and a Roth IRA — can help you join that group.

Use a retirement calculator to get a personalized goal, then motivate yourself to reach it. One fun way to do that is to figure out when your nest egg will hit that $1 million mark. You can use the calculator below to estimate when you’ll unlock the seven-figure badge.

METHODOLOGY

This survey was conducted online within the United States by The Harris Poll on behalf of NerdWallet from June 14-18, 2018, among 2,024 U.S. adults ages 18 and older. This online survey is not based on a probability sample and therefore no estimate of theoretical sampling error can be calculated. For complete survey methodology, including weighting variables and subgroup sample sizes, please contact Megan Katz at [email protected]