Roth IRAs are personal savings plans that allow you to put away money for retirement. Although many people think the term “IRA” stands for “Individual Retirement Account” the term actually stands for “Individual Retirement Arrangement” according to the Internal Revenue Service. Traditional IRAs were created in 1974, as part of the Employee Retirement Income Security Act, to help bridge a retirement gap because many workers were not receiving pension plans from their employers and Social Security benefits would not be enough to provide for a comfortable retirement. Roth IRAs followed in 1997 as part of the Taxpayer Relief Act. Roth IRAs are similar to traditional IRAs, with the biggest difference being that money paid into to a Roth IRA is taxed as it enters. This means you can withdraw funds from a Roth without having to pay taxes during your retirement.

There are several other benefits and features of a Roth IRA that may help you decide if it is appropriate for you.

Roth IRAs are flexible. Under certain conditions, you can take out your contributions at any time without paying taxes or incurring a penalty. Normally, you must hold the Roth account for five years or more at you must be at least 59 ½ years old to avoid paying taxes and penalties, but there are exceptions. These exceptions include the disability or death of the account holder or using up to $10,000 to purchase a home for yourself or qualified family members. If you choose to pay higher education costs for yourself or a family member, you will also avoid the 10% early withdrawal penalty, but you will still have to pay taxes. 

No mandatory withdrawals. Unlike traditional IRAs that require withdrawals starting at age 70½ , Roth IRA account holders are never forced to take withdrawals if they do not want to do so. This gives a higher degree of flexibility for estate planning purposes because heirs pay no income taxes on inherited Roth IRAs.

Continue to save during retirement. If you keep working, you can keep contributing, as long as you stay within certain income limits. With a traditional IRA, you are not allowed to make contributions past age 70½.

Roth IRAs work best for those people who expect their tax rate to be higher during retirement than their current rate. That makes Roth IRAs an excellent investment and savings option for young and lower income workers who can benefit from years and years of tax-free, compounded growth. Roth IRAs are also a preferred investment choice for older and wealthier people who want to leave tax-free assets to their heirs.

The differences between a traditional IRA and a Roth IRA

Although closely related in their purposes, there are some important differences you should note between a Roth IRA and a Traditional IRA:


Roth IRA
Traditional IRA
Age
Contributions can be made at any age and for as long as you want, as long as you are employed and earning wages.
Can make contributions until you turn 70 1/2 as long as you are employed and earning wages. Withdrawals only after that age.
Income Level
Eligibility to contribute restricted based on income levels
Can contribute at any income level, as long as you are employed and earning wages.
Paying taxes
You pay taxes when you make a contribution to avoid paying taxes when funds are withdrawn. Taxes and penalties may be incurred if you withdraw funds prior to age 59½.
You pay taxes when you withdraw funds. Taxes and penalties may be incurred if you withdraw funds prior to age 59 ½.
Tax deductions
on contributions
You can’t claim tax deductions for contributions to your retirement account.
In some instances, you may be able to claim tax deductions for the amount you contributed.
Required
withdrawals
You are not required to withdraw funds at any time or based on any age. If you die, your next-of-kin must take required minimum deductions.
You must begin withdrawing funds within one year of turning 70½.
Beneficiaries
You can select anyone to be your beneficiary in the event of your death.
You can select anyone to be your beneficiary in the event of your death, but if it is not your spouse, he/she must approve of who will receive your IRA funds.
Special circumstances withdrawals
You can withdraw up to $10,000 for a first-time home purchase with no penalties, as long as your Roth IRA is at least five years old. Amounts will vary for other circumstances.
You can withdraw up to $10,000 for a first-time home purchase with no penalties. Amounts will vary for other circumstances.

Eligibility requirements for Roth IRAs

To open a Roth IRA you must meet certain eligibility requirements. At a minimum you must be employed and have income. After that condition is met, how you file your taxes and how much money you make will affect whether or not you are eligible for a Roth IRA. Because requirements for Roth IRAs, traditional IRAs and other investment vehicles change from year to year, you will need to do your homework, consult with a financial advisor or your bank to make sure you do qualify under the most current rules according to the Internal Revenue Service.

Employment: To meet the employment requirement that allows you to open a Roth IRA, you must have income in the form of a salary, hourly wages or income from self-employment or through a small business you own. If you are not employed, you can still qualify for a Roth IRA by accessing your spouse’s income as long as they meet the employment requirement.

Taxes: How much money you make and how you file you taxes will also determine whether or not you qualify to be eligible for a Roth IRA. You must fall within certain ranges that are based on your Modified Adjusted Gross Income. It is similar to Adjusted Gross Income which calculates how much of the money you made in a particular year will be taxed. To determine your AGI, you must take your gross income and subtract any deductions and adjustments. Your Modified Adjusted Gross Income (MAGI) is the calculation that is used by tax preparers and the IRS to figure out how much of your IRA contribution is tax-deductible. To determine your MAGI, some deductions are added back into your adjusted gross income. These can include things such as student loan interest, education payments and foreign income, among others.

Income Levels: After determining your employment eligibility and your Modified Adjusted Gross Income, you must then look at how you files taxes and what your income level is under each scenario.

  • If you file as a single person or head of household, you qualify for a Roth IRA if your MAGI is $129,000 or less.
  • If you file as married, filing jointly, or are widowed, you qualify for a Roth IRA if your MAGI is $191,000 or less
  • If you file your taxes as married, filing separately, and you lived with your spouse during the last year, you qualify for a Roth IRA if your MAGI is $10,000 or less.
  • If you file your taxes as married, filing separately, and you did not live with your spouse during the last year, you qualify for a Roth IRA if your MAGI is $129,000 or less.

Other IRA options

If you do not meet all of the tests that allow you to open a Roth IRA, there are other types of IRAs that may be available to you. Each has it’s own financial parameters that may fit your situation better depending on your age, income, eligibility and retirement plans. Some of those other IRAs include:

Conduit IRA: An account that can transfer between different kinds of IRA plans.

 Rollover IRA: Similar to a traditional IRA, but this account is commonly used by people who have retired or changed jobs and are looking to re-invest their 401(k) accounts.

 SEP IRA: SEP stands for Simplified Employee Pension and is an IRA that your employer contributes to in place of a pension account; it is common for employees of small businesses. Only an employer can make contributions, an employee cannot. It is also a good choice for self-employed individuals as well.

SIMPLE IRA: Short for “Savings Incentive Match Plan for Employees,” this IRA is one your employer contributes to, where they match contributions you make. It is similar to a SEP IRA except that employees can also make contributions as well. This is similar to a 401(k), SIMPLE IRAs have higher contribution limits than traditional or Roth IRAs and are cheaper and easier to set up and administer.

Traditional IRA: This type of IRA does not have limitations on income, so it may give you greater flexibility to fit your circumstances.

Although each of these offer you investing benefits, it’s important to note that regardless of what kind of IRA you choose, you’ll be paying taxes on the money you contribute at either the time you deposit it or whenever you withdraw it. Each has its own specific rules about how you are taxed, how much you can contribute annually, when and why money may be withdrawn, and how long you can keep the account.

How to choose what investments to put into your Roth IRA

In general, there are three different ways that most investors pick investments to go into their IRA.

They can design their own portfolio by picking from thousands of options that are available at brokerages and banks. If this option is chosen, the key rule is to pick investments that match the comfort level of the investor. Investors need to assess their level of risk tolerance and move forward accordingly. The biggest mistake that self-directed investors make with Roth IRAs is moving in and out of certain investment vehicles to quickly based on short-term market conditions. Most financial advisors suggest buying 2 to 6 mutual funds that have a good mix of stocks and bonds, and putting the rest into money market accounts or keeping the balance in cash.

Another way is to put Roth IRA investments into target date funds of lifecycle funds. These investment vehicles diversify over time so that there is less of a chance that investors will experience a large drop in value as they get closer to retirement. A target date fund is designed to replace an investor’s entire retirement account, so it is prudent to buy just a single one.

Finally, many people choose to hire investment advisors to do the research work on their behalf and put appropriate investments into their Roth IRAs. If you are unfamiliar working with financial advisors, start by finding one who holds a Certified Financial Planner designation. This means that they’re licensed and regulated, and that they have taken mandatory classes on all kinds of financial planning. You should also consider the financial planner’s pay structure and whether or not you are comfortable with their fees. 

A good place to start looking for a financial planner is on the websites of the Financial Planning Association and the National Association of Personal Financial Planners. Before selecting a broker, you can find out if a broker on your short list has ever been disciplined for unethical or unlawful behavior by going to the Financial Industry Regulatory Authority’s (FINRA) BrokerCheck.

Opening a Roth IRA

Fortunately, opening a Roth IRA is very similar to opening a regular bank account. No matter which institution you choose, you’ll need to be prepared with important personal information, such as a driver’s license, social security card and banking information for other accounts. If your Roth IRA manager needs other information, they’ll let you know as you go through the application process. If you already have a financial advisor or financial institution you trust, then you might consider opening a Roth IRA through them. But, if you’re looking for another way to open a Roth IRA or don’t know where to start, consider the following:

  • Banks
  • Financial Institutions (such as credit card providers or lenders)
  • Stockbrokers
  • Mutual fund providers
  • Life insurance companies
  • Financial investors or retirement professionals

Converting your traditional IRA to a Roth IRA

As your investing knowledge and goals change in life, you may want to change course in the types of investments you own. After looking at your situation, if you have a traditional IRA and feel you would be better served by a Roth IRA, it is possible to convert from one to the other in what is known as a conversion or a rollover. 

When you do so, you’ll have to pay taxes on your conversion to a Roth IRA because Roth IRA contributions are taxed before they are deposited. Although you’ll pay taxes up front, you could be paying less taxes in the long run because your tax rate might be higher when you retire. If you’re worried about paying taxes during a conversion, don’t panic. Funds you’ve contributed will help you cover what’s due, and you’ll be on track to retire without fear of taxes.

Everything You Need to Know About the Roth IRA Program

A Roth IRA is a kind of personal savings plan that can help you save money in preparation for retirement. Generally, Roth IRAs are set up through a bank or financial institution that helps you determine how much money you contribute annually.

Roth IRAs are different from other kinds of retirement plans, like employer pensions and 401(k)s. While Roth IRAs are similar to traditional IRAs — individual retirement accounts — they have slightly different features and rules that may better suit your savings goals and needs.

The biggest difference between Roth IRAs and other retirement plans is how you are taxed for money you contribute to the account. Money paid into to a Roth IRA is taxed as it enters. This means you can withdrawal funds from a Roth without having to pay taxes during your retirement.

Roth IRAs can be perfect retirement plans for anyone because they generally have fewer age limitations. This kind of IRA doesn’t have age restrictions for when you can open an account, and you won’t be forced to make withdrawals once you reach a certain age (unlike other retirement accounts). This difference makes Roth IRAs great options for individuals who are early in their career, or looking to start saving closer to retirement.

If you qualify for a Roth IRA, you’re on your way to creating a strong financial plan for retirement. Roth IRAs are ideal for supplementing other retirement funds you may receive, like Social Security benefits or an employer pension. Roth accounts can help maximize your savings while giving you more control over your retirement funds. And, Roth IRAs can be modified as your financial and retirement goals change.

What is an IRA?

If you feel a little lost with IRAs, it’s a good first step to understand what they are!

What does “IRA” stand for?

Individual Retirement Arrangements. While many confuse the “A” for “accounts,” the Internal Revenue Service (the IRS) refers to IRAs as “Individual Retirement Arrangements.” IRAs launched in 1974, as part of the Employee Retirement Income Security Act. At the time, the U.S. Government recognized that many workers didn’t receive pension plans from their employers, and that Social Security benefits wouldn’t be enough to provide them comfortable retirements. IRAs were created to help Americans save for their own retirements. Roth IRAs are the much younger sister of traditional IRAs, and appeared in 1997 following the Taxpayer Relief Act.

In the most basic sense, IRAs are savings accounts that you contribute money to in preparation of retirement. An IRA has a varying portfolio of ways to invest your money, all based on your personal level of risk (because of this, every person’s IRA will be different). In this way, the IRA account generates profit from funds you invested, which helps your retirement savings grow faster than what they would have sitting in a low-interest savings account. Generally, IRAs can be opened at almost any bank, financial lender or institution, and an account manager will help you make the most of your investments while guiding your account’s potential.

Are there only two kinds of IRAs? No! There are many.

Traditional and Roth IRAs aren’t the only kind of individual retirement accounts, though they are the most common. Each kind of IRA has its own rules and features and may fit your financial situation better depending on your age, income, eligibility and retirement plans, could fit your financial situation best. For example:

Conduit IRA: An account that can transfer between different kinds of IRA plans.

Rollover IRA: Similar to a traditional IRA, but this account is commonly used by people who have retired or changed jobs and are looking to re-invest their 401(k) accounts.

Roth IRA: An account where money is taxed as it’s added to the account, and withdrawals are tax-free. There are fewer age and withdrawal requirements than traditional IRAs.

SEP IRA: An IRA that your employer contributes to in place of a pension account; common for employees of small businesses.

SIMPLE IRA: Short for “Savings Incentive Match Plan for Employees,” this IRA is one your employer contributes to, where they match contributions you make. This is similar to a 401(k).

Traditional IRA: Your contributions are tax-deductible each year you make them, but your withdrawals at retirement are taxed.

IRAs aren’t tax-free, though. It’s important to note that regardless of what kind of IRA you choose, you’ll be paying taxes on the money you contribute at either the time you deposit it or whenever you withdrawal it. Each form of IRA has its own specific rules about how you are taxed, how much you can contribute annually, when and why money is withdrawn, and how long you can keep the account.

IRA Terminology You Should Know

When it comes to understanding and managing an individual retirement arrangement, there’s quite a bit of terminology you should become familiar with. The most important terms are:

Contributions: Money you deposit into your IRA that is invested; this generates earnings that will help your retirement savings grow.

Earnings: Money that you earn from your IRA investments.

Portfolio: The variety of stocks, bonds and other financial accounts within your IRA that you invest in as a way to generate profit.

Withdraw: The process of removing funds from your IRA account. This is when you are able to reap the rewards of your contributions.

How a Roth IRA Works

Roth IRAs follow the basic form of an IRA — you invest money that generates profit, helping to grow your savings. But, the process for how you’re taxed on contributions and when you can withdraw money from your account has limitations.

When making a contribution to a Roth IRA, you’ll first be taxed on funds going into the account. This means that profit generated in your account can grow without worry of future taxation. Because you paid taxes on contributions going into the Roth IRA, you won’t have to pay taxes when you withdraw money! This perk to Roth IRAs is beneficial, especially as your earnings grows, because it’s possible to invest more and more money with larger, tax-free returns and no taxes (more contributions equals the possibility of larger withdrawals).

Roth IRAs tend to have fewer stipulations to how long you can make contributions. Unlike traditional IRAs, Roth IRAs can be opened by anyone at any age so long as you are employed and have earnings (or access to income, in the case of non-working spouses). And, Roth IRAs don’t force you to begin withdrawing money by certain ages, unlike traditional IRAs. In fact, the only time funds from a Roth IRA must be used is when the original owner dies, and the account is passed on to an heir or next of kin.

But, like many savings accounts, Roth IRAs do require your contributions to be in the account for at least five years before you plan to use them. It is possible to open a Roth IRA closer to retirement, so long as you account for the five-year waiting period before withdrawing any funds.

How Roth IRAs Differ From Traditional IRAs

Roth IRAs are the younger sister of traditional IRAs. While the popular traditional IRA first appeared in 1974, Roth IRAs weren’t created until 1997. Roth IRAs are a closely related spin-off of traditional IRAs, but with some important differences to note — specifically about taxes and how they can be used.

Age

Traditional IRA: With a traditional IRA, you can only make contributions until age 70 ½, so long as you are employed and earning income. At and after reaching age 70 ½, you’ll only be able to withdraw money.

Roth IRA: With a Roth IRA, you can make contributions at any age, and for any period of time (until your death) so long as you are employed and earning income.

Income Level

Traditional IRA: Anyone at any income level can contribute money to a traditional IRA, so long as they’re employed and earning money.

Roth IRA: Roth IRAs restrict eligibility by your income level, which accounts for all income available to you (in the situation you are married and file taxes jointly). To qualify for a Roth IRA, your adjusted gross income (AGI) must fall between certain thresholds.

Taxes on Contributions and Withdrawals

Traditional IRA: With a traditional IRA, you pay taxes when you withdraw funds at retirement. Because of this, you don’t have to pay taxes when you contribute money to your IRA. Although you may be responsible for additional taxes or penalties if you withdraw funds prior to age 59 ½.

Roth IRA: With a Roth IRA, you pay taxes on money you contribute as it is deposited, meaning you won’t have to pay taxes on money you withdraw after retirement. Although you may be responsible for additional taxes or penalties if you withdraw funds prior to age 59 ½.

Tax Deductions on Contributions

Traditional IRA: When tax time rolls around, you may be able to claim deductions for the amount contributed to your IRA account, especially if you don’t have a retirement plan through work.

Roth IRA: With a Roth IRA, you can’t claim tax deductions for contributions to your retirement account.

Required Withdraws

Traditional IRA: A traditional IRA requires you to begin withdrawing funds within a year of turning age 70 ½. This process is called a “required minimum distribution” and outlines how much money you must withdraw every year.

Roth IRA: Roth IRAs do not require you to withdraw funds based on age, or at any time. Although it’s important to note that if you own a Roth IRA and pass away, your heir or next-of-kin will be required to take the required minimum distributions.

Beneficiary

Traditional IRA: With a traditional IRA, you can select anyone to be the beneficiary of your account. If you are married, and the beneficiary is not your spouse, your spouse must approve of who will receive your IRA funds.

Roth IRA: If you have a Roth IRA, you can select anyone to be the beneficiary of your account in the case of your death, and there are no restrictions on spousal approval.

Withdrawing for Special Circumstances

In some scenarios, you may need to rely on retirement funds you squirreled away to pay for big life purchases, such as a new home or paying for a child’s college education. Withdrawing money early to cover these situations is possible, but how and what you can withdraw without penalty varies between these two kinds of IRAs.

Traditional IRA: You can withdraw up to $10,000 for a first-time home purchase without being penalized. Amounts may vary for other circumstances.

Roth IRA: You can withdraw up to $10,000 of earnings for a first-time home purchase without being penalized, but your Roth IRA must be at least five-years-old. Amounts may vary for other circumstances.

NOTE: If you withdraw funds before age 59 ½, you may be required to pay an additional 10% tax. Be sure that you understand any penalties or taxes you may be required to pay for withdrawing funds from your Roth IRA prior to doing so. Requirements for withdrawals may vary year to year based on government regulations. Be sure to check with the Internal Revenue Service (RIS) for the most up-to-date information.

Understanding Roth IRA Eligibility Requirements

Many people can qualify for a Roth IRA, but it's important to know that there are eligibility requirements. Your ability to open a Roth IRA is based on:

If you are employed and have income

  • How you file your taxes
  • How much money you make

These factors can affect whether you are eligible for a Roth IRA, or should consider another form of retirement savings (such as a traditional IRA).

NOTE: It is important to know that eligibility requirements for Roth IRAs (and other forms of retirement plans like traditional IRAs) vary year to year, based on government regulations. The range for allowable income may vary, so its important to determine if your particular financial situation qualifies you for a Roth IRA based on the most up-to-date information provided by the Internal Revenue Service (IRS).

Employment

The first requirement to obtain a Roth IRA is that you are employed, and have access to income. To meet this requirement, your income must come from one of these sources:

Hourly wages 

Salary 

Self-employment or employment through a small business

If you are not employed, you must have access to income through a spouse. Non-working spouses are eligible for a Roth IRA that is contributed to by their spouse’s income. But, that spouse must meet the employment requirement.

Example. Donna works 20 hours per week at a local grocery store, and is paid weekly. Because Donna is employed and receives hourly wages, she passes the first eligibility requirement for a Roth IRA.

Example. Matt is a stay-at-home dad who does not work. His wife, Martha, is employed as a salaried university professor. Because Matt has access to Martha’s income, he passes the first eligibility requirement for a Roth IRA.

Example. Daniel is a retiree who does not work. Because Daniel is not employed and does not earn income, he is not eligible for a Roth IRA.

Tax Status and Income Level

How you file your taxes, and how much money you make, also impacts your eligibility for a Roth IRA. Whether you file your taxes as a single person or married, there are income thresholds you must fall within to qualify for a Roth IRA based off your Modified Adjusted Gross Income (MAGI).

Understanding Modified Adjusted Gross Income (MAGI)

Modified Adjusted Gross Income (MAGI) is used to determine if you qualify for a Roth IRA. But what is it? You may be familiar with Adjusted Gross Income, but there’s a difference between these two calculations.

Adjusted Gross Income: This calculation determines how much of the money you made will be taxed. In many cases, your AGI can affect what tax deductions and credits you’re eligible for. To find it, you must take your gross income and subtract any adjustments.

Modified Adjusted Gross Income: This calculation is often used by tax preparers and the IRS to find out how much of your IRA contribution is tax-deductible. To find your MAGI, certain deductions (like student loan interest, education payments and foreign income) are added back to your adjusted gross income.

In some cases, your MAGI may be the same as your Adjusted Gross Income. If you have difficulty determining your AGI or MAGI, you can find guidance and worksheets for both calculations on the IRS website (www.irs.gov).

If you file your taxes as a single person or as head of household:

You qualify for a Roth IRA if your MAGI is $129,000 or less

If your MAGI is $129,001 or more, you do not qualify

Example. Alex is unmarried and files his taxes as a single person. Because his MAGI is $56,000, he qualifies for a Roth IRA.

Example. Shannon is unmarried and files her taxes as a single person. Because her MAGI is $133,000, she does not qualify for a Roth IRA.

If you file your taxes as married, filing jointly, or are widowed:

You qualify for a Roth IRA if your MAGI is $191,000 or less

If your MAGI is $191,001 or more, you do not qualify

Example. David and Nicole are married, and file their taxes jointly. Because their MAGI is $86,000, they both qualify for a Roth IRA.

Example. Shane and Margaret are married, and file their taxes jointly. Because their Magi is $245,000, they do not qualify for Roth IRAs.

Example. Beth is widowed, and files her taxes accordingly. Because her MAGI is $43,500, she qualifies for a Roth IRA.

If you file your taxes as married, filing separately, and you lived with your spouse during the last year:

You qualify for a Roth IRA if your MAGI is $10,000 or less

If your MAGI is $10,001 or more, you do not qualify

Example. George is married and lives with his wife, but files his taxes separately. His MAGI is $8,500. He qualifies for a Roth IRA.

Example. Sheryl is married and lives with her husband, but files her taxes separately. Her MAGI is $22,000 — too high for a Roth IRA. She is not eligible.

If you file your taxes as married, filing separately, and you did not live with your spouse during the last year:

You qualify for a Roth IRA if your MAGI is $129,000 or less

If your MAGI is $129,001 or more, you do not qualify

Example. Margaret is married, but filed her taxes separately. She did not live with her husband during the last year. Because her MAGI was $33,000, she qualifies for a Roth IRA.

Example. Mike is married, but filed his taxes separately. He did not live with his husband during the last year. Because his MAGI was $131,000, he does not qualify for a Roth IRA.

NOTE: It is important to know that eligibility requirements for Roth IRAs vary year to year based on tax codes and government regulations. The range for allowable income may vary, so its important to determine if your particular financial situation qualifies you for a Roth IRA based on the most up-to-date information provided by the Internal Revenue Service (IRS).

Understanding Roth IRA Rules

Like many kinds of retirement accounts, there are rules to how you use your Roth IRA without being penalized — which often comes in the form of financial fees. To avoid penalties, and to get the most from your retirement efforts, it’s important to know the basics of Roth IRA management.

Age

Unlike traditional IRAs and other retirement plans, there are very few age-related restrictions with Roth IRAs. You can open a Roth IRA at any age, and contribute to it as long as you please, given that you are employed and have access to income.

While age is generally not an issue with Roth IRAs, you should know that beginning to withdraw earnings before age 59 ½ can lead to penalties (though you can withdraw contributions). Because Roth IRAs are meant to help you save for retirement, using funds before you reach retirement age could lead to penalties. That tax can be as high as 10% of the money you withdraw. While there are some scenarios where funds can be used tax and penalty-free before age 59 ½ (such as buying a first home or paying for a college education), they are generally few. It’s important to understand how your potential withdrawal before age 59 ½ could impact your account and additional fees you may pay.

A perk to Roth IRAs is that there’s no required withdraw time, meaning you can leave funds in a Roth IRA to use at a certain age or pass on to a beneficiary (like a spouse or an heir). But, know that this option means they’ll be required to begin withdrawing money just like a traditional IRA.

Contribution Limits

While saving can be beneficial for your golden years, there are rules about how much you can save each year.

Maximum amount. The amount you can contribute to your Roth IRA varies by income, but is capped at $5,500 (as of 2016), regardless of tax filing status or how much you make.

Example. Jeff earns $110,000 per year. His friend Allen earns $43,000 per year. Even though their incomes are drastically different, both men can only contribute a maximum of $5,500 to their Roth IRA accounts. 

Playing catch up. The only exception to the maximum amount rule is for investors getting close to retirement age. Individuals who are 50 years or older can contribute up to $6,000 (as of 2016) to their Roth IRAs under the “catch up” rule, which allows older individuals to save extra as they near retirement.

Example. Marianne is 52 years old and still contributing to her Roth IRA. Because she’s over age 50 and close to retirement, she can contribute up to $6,000 per year. 

Maximum amounts on limited income. If you are a lower-income investor, note that your maximum may be less than $5,500. According to the IRS, contributions to your Roth IRA can’t be more than your taxable income.

Example. Janet has $2,500 in taxable income. This means she can’t invest anymore than $2,500 in her Roth IRA for the year.

Contribution Time

Looking at those annual contribution maximums may have you wondering how you’ll save $5,500 in one year. If you’re looking to max out on your contribution each year, don’t fret — there’s more time than you think. Because of tax filing laws, you can make your annual contribution in the span of 15 months instead of 12.

Since taxes are filed by April of each year, investors can continue contributing to a year’s savings until they file their taxes. For example, contributions for 2016 can be made between January 2016 and April 2017, giving your annual investments a boost by three extra months.

And because there’s no age requirement that forces you to stop contributing to your Roth IRA, you can take advantage of this 15-month trick for as long as you like, even after reaching retirement age (if you’re still employed).

Withdrawals

Utilizing a Roth IRA is a great move for creating a retirement nest egg. Which is exactly why penalties exist that aim to prohibit you from withdrawing and using retirement funds before your gold years arrive.

Withdrawing funds from your Roth IRA isn’t necessarily a bad thing, but doing it too early can negatively impact your account. While you can withdraw contributions you made to your Roth IRA at anytime, you can’t do the same with earnings. As a rule, your Roth IRA account must be at least five-years-old before you can begin withdrawing funds — even if you’re at retirement age. This rule exists to ensure your withdrawals during retirement will remain tax-free.

Even if your account is five-years-old, withdrawing is still frowned upon if you’re under age 59 ½. Pulling earnings in years prior to retirement means you could be taxed as much as 10%, as well as other penalties that may apply.

Sometimes, you may need to utilize those retirement savings to cover big expenses, such as a new home (if you’re a first-time buyer) or a child’s college education. Withdrawing money early to cover these situations is possible, but is limited; with a Roth IRA, you can use up to $10,000 of your earnings, so long as your account is five-years-old.

The biggest perk of a Roth IRA is that your withdrawals are tax-free, so long as you followed the rules. When retirement rolls around, you’ll be able to pull funds at your discretion without having to worry about paying taxes.

NOTE: If you look to withdraw funds before retirement, consider speaking with a financial advisor to know what penalties may apply to you. Penalties and tax fees may vary for each situation, and by tax year.

There are many ways to go about opening and setting up a Roth IRA, simply because there are many financial providers who offer Roth IRA services! But, knowing where to start can seem overwhelming with so many options. To get started on (or add to) your retirement goals only takes a few steps:

  • Select a financial advisor or investment institution
  • Apply for an account
  • Begin making contributions to your Roth IRA

Where to Open Your Roth IRA

If you already have a financial advisor, banking or financial institution you trust, then it may be a smart move to open a Roth IRA through them. But, if you’re looking for another way to open a Roth IRA or don’t know where to start, consider looking down these avenues:

  • Banks
  • Financial Institutions (such as credit card providers or lenders)
  • Stockbrokers
  • Mutual fund providers
  • Life insurance companies
  • Financial investor or retirement professional

Whichever path you take to creating your Roth IRA, be sure you select a trusted provider who can help evaluate your financial situation accurately. You’ll want to select your account manager or financial institution with scrutiny. Learn how they’ll help you meet your goals by asking:

  • If there are fees associated with opening or maintaining your Roth IRA 
  • What the minimum amount to open your Roth IRA will be 
  • What kinds of investments are available 
  • Who will be managing your account, or how “hands on” you will need to be 
  • How will you be able to monitor your account (online or over the phone)

Like many retirement savings accounts, it’s unwise to create a Roth IRA and forget about it. Monitoring your retirement investments means you can have a better understanding of what does and doesn’t work for you, without surprises at retirement time.

Applying for a Roth IRA

The application for a Roth IRA is similar to that for opening a bank account, so you’ll need to be prepared with important personal information, such as a driver’s license, social security card and banking information for other accounts. If your Roth IRA manager needs other information, they’ll let you know as you go through the application process.

Begin Making Contributions

After you’ve gone through the setup process, be sure to start contributing to your Roth IRA! Every Roth IRA provider may have different limitations on how much money you can contribute per month (adding up to no more than the annual limit), so be sure to determine if this amount works for you. The earlier you take advantage of investing in your account, the more time you’ll have to grow your retirement savings, even if it’s just a small, monthly contribution.

Converting Your IRA to a Roth IRA

If you already have a retirement account in place, good work! But, if you feel that a Roth IRA could better meet your financial goals, there’s no need to start an entirely new plan. It is possible to convert traditional IRAs into Roth IRAs in what’s called a conversion or rollover.

During this process, you’ll be responsible for paying income tax on your contributions because contributions in a Roth IRA are taxed before they are deposited. Converting from a traditional to a Roth IRA can help you save money over the course of your investing and retirement planning, because you’ll be paying taxes up-front, instead of at retirement when tax rates could be higher.

If you’re worried about paying taxes during a conversion, don’t panic. Funds you’ve contributed will help you cover what’s due, and you’ll be on track to retire without fear of taxes.

NOTE: If you feel a switch to a Roth IRA is a strong financial move for you, contact your account manager to learn how to make the conversion. Their guidance will help you determine the specifics of your individual situation, and if conversion is best for your retirement goals.

Options For Those Who Don’t Qualify for a Roth IRA

If you don’t qualify for a Roth IRA, it’s likely because you don’t have access to income or because your income is too high. In the latter of both cases, you still have options for setting up a retirement savings account.

Consider a traditional IRA. Because traditional IRAs do not have limitations on income, this option can fit your circumstances. Investing with a trusted bank, financial institution or investing professional can help get your retirement goals on track.

Consider a backdoor Roth IRA. Loopholes in regulations for Roth IRAs mean that you still may be able to open a Roth IRA even if you make too much money. A backdoor Roth IRA is when a traditional IRA is converted into a Roth IRA. Because anyone can convert to a Roth IRA (regardless of income level), this could be a beneficial option. Be sure to speak with a financial planner about the ins and outs of backdoor Roths.

Consider other kinds of retirement accounts. 401(k)s or other kinds of IRAs may work best depending on your financial situation. Speaking with a financial advisor is the best way to determine what kind of retirement savings plan you should open and maintain.

Where to Learn More About Roth IRAs

Because many financial institutions offer Roth IRAs and financial planning, there are many avenues to learning more about setting up or managing this kind of retirement account.

If you already have a retirement account:

If you already have an IRA, Roth IRA or other kind of retirement account, contact your account manager to determine if you qualify for a Roth IRA and how to open or access one. You may also consider converting to a Roth IRA if you have an existing IRA.

If you’re looking to open a Roth IRA:

If you think you qualify for a Roth IRA and are interested in jumpstarting your retirement savings, consider searching for and speaking with accredited, professional lenders or financial planners. Companies like E*Trade and Fidelity can help you get started. Or, you can speak with a bank, life insurance company or other financial lender you already have a relationship with about their retirement options.

For general information about Roth IRAs:

The Internal Revenue Service (IRS) features the most up-to-date information on Roth IRA thresholds, tax requirements and restrictions, and other codes on retirement saving. To learn more about Roth IRAs, visit the retirement planning section of the IRS website (www.irs.gov/Retirement-Plans).