What is a Roth IRA?

What is a Roth IRA?

An IRA, or Individual Retirement Account, is a tax-advantaged account designed to help you save for retirement. Unlike employer-sponsored retirement accounts such as 401(k)s or 403(b)s, IRAs can be opened by an individual. They are a good option to consider if you want to save for retirement and are self-employed, your employer doesn’t offer a retirement plan, or you’d like to save in addition to your workplace retirement plan.

Unlike a traditional savings account in a bank or credit union that simply earns interest, Roth IRAs can be invested in a variety of ways to potentially grow your savings over the long term. 

There are two types of IRAs: traditional IRAs and Roth IRAs. The difference between them is the timing of the tax benefits you receive. Learn more about IRAs here.

Here are the answers to ten frequently asked questions about Roth IRAs:

1. How is a Roth IRA different from a traditional IRA?

Contributions to a Roth IRA are made with after-tax income, so earnings and withdrawals in retirement are not taxed. This is unlike a traditional IRA, where you do not pay taxes when you make a contribution, but withdrawals in retirement are taxed as income.

A unique advantage to Roth IRAs is that contributions to your account can be withdrawn at any time. But earnings on your interest can only be withdrawn penalty-free in retirement, with some exceptions.

2. How do I open a Roth IRA?

Unlike an employer-sponsored retirement plan, you get to decide where to open your IRA, and you have many options. Roth IRAs are offered by most banks, credit unions, brokerage firms, and mutual fund companies.

3. Can anyone open or contribute to a Roth IRA?

No, there are income restrictions on who can open a Roth IRA. Single tax filers in 2016 must have an income below $132,000, and married couples filing taxes jointly must have an income below $194,000, to open or contribute to a Roth IRA.

4. What are the contribution limits to a Roth IRA?

The 2016 contribution limit to Roth IRAs is $5,500 (or $6,500 if you are age 50 or older). But single tax filers in 2016 earning $117,000 or more, and married couples filing jointly earning $184,000 or more, have reduced contribution limits that you can learn about here.

You can never contribute more than you’ve earned in income for the year.

5. Which is better for me, a Roth IRA or a traditional IRA?

Whether a Roth IRA is a good option for you depends on if you want to pay the taxes now with a Roth IRA or later with a traditional IRA. If you expect your tax rate to be higher in retirement than it is today, a Roth IRA may be a good option for you. Some people also open both traditional and Roth accounts to add tax diversification to their retirement accounts. 

6. How much does a Roth IRA cost?

First, look to the investment’s underlying expenses, including operating expenses and commissions. Then, look to whether the investment is managed by a financial professional. A good rule of thumb is to look for a Roth IRA with fees below 1 percent.

7. When can I withdraw money from my Roth IRA?

Because you already paid taxes on the money, all Roth IRA contributions can be withdrawn penalty-free and tax-free at any time at any age.

You can begin to take penalty-free distributions of your Roth IRA earnings at age 59 ½, as long as you made the first contribution at least five years earlier.

You can withdraw earnings from your IRA for retirement, or earlier if you are a first-time homebuyer or paying for higher education for yourself, your spouse, your children, or your grandchildren.

If you are a first-time homebuyer, you can withdraw up to $10,000 from your Roth IRA without needing to pay any taxes on the investment earnings, as long as you made the first contribution at least five years earlier.

If you are paying for college expenses for yourself, a spouse, your children, or your grandchildren, Roth IRA distributions are penalty-free at any age, as long as you made the first contribution at least five years earlier.

Learn about the additional limited exceptions that allow for early distributions, including disability and military reservists called to active duty, here.

8. Are there any other types of Roth accounts that aren’t IRAs?

Yes, some employers offer a Roth 401(k) option. 

9. What does the word “Roth” mean?

Roth accounts are named after William Roth, a former U.S. senator. He was the chief sponsor of the Taxpayer Relief Act of 1997, which established Roth IRAs.

10. I opened a Roth IRA. Now what?

Good question. Saving money, improving your financial life, building wealth, it all starts when you set a goal and make a plan to reach that goal because savers with a plan are twice as likely to save successfully. That’s where America Saves comes in. We’ll help you make a plan and a commitment to yourself to save. That’s what our America Saves Pledge is all about. Get started today by coming up with a monthly savings plan, and then pledging to save money, reduce debt, and build wealth over time. And it doesn’t stop there. America Saves will keep you motivated with information, advice, tips, and reminders to help you reach your savings goal. Think of us as your own personal support system.

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