Roth individual retirement accounts (IRAs) are just one option for retirement savings, but they come with a unique set of benefits. Let’s take an in-depth look at how Roth IRAs work, as well as how they compare to traditional IRAs.
What is a Roth IRA?
A Roth IRA is a tax-advantaged retirement account that allows you to contribute after-tax dollars. That money can grow and be withdrawn tax-free once you meet certain requirements.
How does a Roth IRA work?
When you open a Roth IRA, you can contribute post-tax money that grows tax-free. As of 2024, you can make a maximum annual contribution of $7,000 or $8,000 if you're 50 or older. Any distributions you take won’t be taxed if you make them after age 59 1/2 and the account is at least 5 years old.
Contributions to your Roth IRA go into an investment portfolio, which may include stocks, ETFs, mutual funds or high-yield savings options, such as money market accounts or CDs.
How do you invest in a Roth IRA?
To invest in a Roth IRA, you must first open one with a broker, bank or other financial institution. To open an account, you must have a government-issued ID, proof of residence within 60 days of the application and income eligibility through “earned income,” which is active income earned from an employer or business.
You can choose a target-date fund (funds that include a mix of investments and are designed to adjust over time, prioritizing more stable investments as you get closer to your retirement date) or manage investments yourself. You may want to work with a broker or advisor to choose investments that can help grow your money.
Roth IRA advantages
Roth IRAs offer several advantages, including:
Tax-free withdrawals
Withdrawals made after age 59 ½ from an account you’ve had for at least 5 years aren’t taxed. Distributions don’t affect your taxable income for the year, so withdrawing strategically can help you manage taxes.
No required minimum distributions
Roth IRAs don’t have required minimum distributions (RMDs) for their original owner. This means you never have to start withdrawing money from your Roth IRA. If you’re still working, or even if you want to grow your IRA and let a loved one inherit it, you don’t have to make any withdrawals. However, once someone inherits a Roth IRA, RMDs may apply.
Withdraw contributions at any time
You can withdraw the contributions you made at any time without having to pay taxes or penalties. However, you may have to pay taxes or a penalty on any earnings.
Withdraw qualified distributions before retirement without penalty
Roth IRAs allow you to withdraw some earnings before retirement age for “qualified distributions.” You can take these distributions for specific purposes, such as a first-time home purchase, without having to pay a penalty.
Roth IRA disadvantages
While Roth IRAs offer several benefits, there are some rules and restrictions to be aware of.
Contributions aren’t tax-deductible
Because contributions to a Roth IRA are made with post-tax money, you can’t deduct them on your taxes the way you can with a traditional IRA. This is great for retirees who will be in a higher tax bracket upon retirement than when they opened the IRA. However, anyone retiring in a lower tax bracket may end up paying a higher tax rate upfront.
Income and contribution limits
Roth IRAs have a maximum contribution limit. As of 2024, you can contribute up to $7,000 per year, and up to $8,000 if you’re 50 or older. If you make above a certain income (the amount differs depending on whether you’re filing as single; married, filing jointly or married, filing separately), that number may be lower, or you may not be eligible to contribute at all.
5-year contribution rule
You can’t withdraw any earnings tax-free until a minimum of 5 years has lapsed since your first contribution. While this rule may not affect accountholders who open a Roth IRA early on, it could make a difference if you decide to open a Roth IRA closer to retirement.
Traditional vs. Roth IRA
Traditional and Roth IRAs are both tax-advantaged retirement accounts, but there are several key differences.
Tax-deferred contributions vs. tax-free withdrawals
Traditional IRAs allow for tax-deferred contributions (contributions are typically tax-deductible, but withdrawals will be taxed in retirement), while Roth IRAs allow for tax-free withdrawals (contributions are post-tax, but withdrawals can be tax-free in retirement).
Both types of accounts are beneficial in different situations. It will ultimately come down to whether you believe your income tax will be higher at the time of contribution or at the time of withdrawal. If your tax bracket is higher at the time of contribution, a traditional IRA may benefit you more. If it’s higher at the time of withdrawal, a Roth IRA may make more sense.
Required minimum distributions
When you reach age 72 (73 if the account owner reached age 72 in 2023 or after), you must start taking RMDs from your traditional IRA each year or face a penalty. Roth IRAs do not have this rule – you can keep growing your Roth IRA without RMDs as long as you live.
Income eligibility
There are no income limits to be eligible to contribute to a traditional IRA. However, if a single filer makes over $77,000 and has access to a retirement plan at work, they won’t be able to deduct the full amount of traditional IRA contributions. If a single filer makes over $87,000, they won’t be able to deduct any contributions. For married couples filing jointly, the partial deduction begins with income over $123,000, with a phase-out of deductions when income surpasses $143,000.
If someone is not covered by a retirement plan at work, as a single filer, they can deduct up to the amount of their annual traditional IRA contributions, regardless of income. Deductions for married couples where one spouse is covered by a plan at work will be limited if income is over $230,000, with a full phase-out and the inability to deduct contributions if income is over $240,000.
Roth IRAs come with income limits on contribution eligibility. In 2024, if a single filer makes more than $146,000 per year, they’ll only be eligible to contribute a reduced amount, with the inability to make any contributions if income is over $161,000. For married couples, the phase-out begins at $230,000, with the inability to contribute when income surpasses $240,000.
Are Roth IRAs insured?
A Roth IRA can be FDIC-insured as long as the contributions in the portfolio are invested in FDIC-insured banking products, such as money market accounts, CDs, savings accounts and checking accounts. If you invest in securities, such as stocks or ETFs, these investments will not be insured.
What are the Roth IRA withdrawal rules?
Once you reach age 59 ½ and have had your account for at least 5 years, you can withdraw funds without penalty.
Under certain conditions, such as a medical disability or a first-time home purchase, you can withdraw up to a certain amount before age 59 ½ without paying a penalty.
If you are under 59 ½ and don’t meet any of the other requirements for a qualified distribution, you may have to pay a penalty.
Opening a Roth IRA
To open a Roth IRA, you’ll need to fill out an application with your broker, bank or financial institution of choice.
After, you can start making weekly, monthly or annual contributions to your Roth IRA, which you can invest in whichever assets suit your financial needs.
Disclosure: This article is for educational purposes about banking products. It is not intended to provide legal, investment, tax, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should refer to the disclosures financial institutions provide for various products and consult a qualified professional.
