What is a Roth IRA? How to take advantage of after-tax benefits when saving for retirement (2024)

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• A Roth IRA is a retirement account you can use to invest in stocks, bonds, and other securities.
• You fund Roth IRAs with post-tax dollars so you don't pay income tax on retirement age withdrawals.
• Roth IRAs are most advantageous for people who expect to pay higher taxes in the future.

When saving for retirement, you have many options to choose from. There are 401(k)s, 403(b)s, thrift savings plans, and several types of IRAs.

Though any of these vehicles can help you grow your wealth and live a comfortable retirement life, Roth IRAs are the only ones you can draw from tax-free. This can be particularly beneficial when you're older, on a limited income and potentially facing higher income taxes.

Here's what you need to know about these valuable types of retirement accounts.

What is a Roth IRA?

A Roth IRA is a type of individual retirement account that you fund with after-tax income — or money you've already paid income taxes on.

This means you won't pay taxes when withdrawing from your account later on, even if your tax bracket changes. Because of this, Roth IRAs can be advantageous for those who are in the early stages of their careers, as it allows more time for the investments to grow (and you may be in a lower tax bracket when you're just starting out).

"Roth IRAs are a type of individual retirement account in which you pay taxes now rather than later," says Hannah Whatley, an advisor and CFP at Rather & Kittrell Wealth Management. "The beauty of this is that your earnings are growing tax-free. This is often especially advantageous for young savers, who may not be in their peak earning years and also have plenty of time for the tax-free growth to compound."

Anyone can open a Roth IRA — so long as they have earned income, which is one of the few ways to fund this type of account. You'll just choose a brokerage, and a representative will help you open the account in your name. You can then begin funding your account, choosing investments, and building toward retirement.

How a Roth IRA works

Roth IRAs are funded with post-tax dollars. Once an account is funded, you can use the cash to invest in stocks, bonds, ETFs, mutual funds, and other securities. As these grow in value, so does your Roth IRA balance, which you can then withdraw from in retirement.

"I get asked frequently, 'What is the return of a Roth IRA?'" says Sean Burke, CFP and VP branch leader at Fidelity. "The Roth IRA is simply a shell to protect you from taxes. Within that shell, you can invest in many different securities. The return of your Roth IRA depends on how the underlying investments perform."

There are several ways to fund a Roth IRA. These include:

• Direct contributions: You can contribute using a check or electronic funds transfer from your bank account.
• Spousal contributions: If you file a joint tax return and make less than your spouse, you can contribute to a Roth IRA in their name (and vice versa).
• Rollovers: Funds from 401(k)s and other employer-sponsored retirement plans can be rolled over into a Roth IRA account.
• Conversions: You can also convert an entire traditional IRA account into a Roth IRA. This is often referred to as a "backdoor" Roth IRA and can help you avoid contribution limits.

Keep in mind that with rollovers and conversions, you will need to pay income taxes on the amount of money you move or convert.

Roth IRA withdrawal rules

Since Roth IRAs are technically retirement accounts, you're not supposed to withdraw funds until at least age 59.5. If you withdraw money before this point, you'll pay a 10% penalty on the total amount withdrawn.

Unlike traditional IRAs, there are no required monthly distributions (RMDs), so even once you reach age 72 — when you'd need to start withdrawing on a regular IRA, you can leave the funds to keep growing or even contribute more if you'd like.

"You can invest in a Roth IRA beyond the RMD age of 72 and take advantage of tax-deferred growth," says Matt Rogers, director of financial planning at eMoney Advisor. "This is a useful tool to control your taxable income in retirement and supplement it with tax-free Roth IRA distributions — a move that is quite tactical."

Annual Roth IRA contribution limits 2023 and 2024

There are limits to how much you can contribute to a Roth IRA. For one, you can only contribute up to $7,000 per year if you're 49 or younger. If you're 50 or older, the limit is $8,000.

Contributions are also limited by household income. Here's a breakdown:

Roth IRA vs. 401(k)

A 401(k) is another type of common retirement account, though these function very differently than Roth IRAs. One is opened by individuals, while the other is offered by employers only.

"A 401(k) is an employer-sponsored plan only offered through employers as a workplace benefit," Rogers says. "A Roth IRA can be used by anyone who has earned income regardless of whether their employer offers a 401(k) or not."

The two accounts also come with different tax treatments, which is critical to think about when saving for retirement. With 401(k)s, you fund the account using pre-tax dollars and then pay taxes on your withdrawals later on. Roth IRAs are the opposite.

Here's a full breakdown of how the two types of accounts differ:

6 key benefits of a Roth IRA

Roth IRAs come with many benefits for those who use them. They allow you to grow your retirement savings tax-free, they don't require minimum distributions, and they can help you avoid costly taxes once retired. Learn more about these and other advantages below.

1. They offer tax-free investment growth

Potentially the biggest benefit of Roth IRAs is that they let you grow your retirement funds tax-free. As your account grows, you won't pay extra taxes on what it earns, nor will you be taxed when you withdraw the funds later on in retirement.

As David Rosenstrock, director and founder of Wharton Wealth Planning, explains: "The reason these plans are so important is that they combine the power of compounding with the benefit of tax-free growth."

These tax-free accounts can prove helpful come retirement, reducing your costs and freeing up cash flow at a time when your income may be very limited.

2. You can withdraw money any time with no penalties

Unlike most retirement accounts, Roth IRAs don't limit your withdrawals to just retirement age (or when you're nearing it). With these, you can actually withdraw any money you've contributed to the account at any time — with no penalty at all.

Be careful, though: While contributions can be withdrawn penalty-free, earnings on those contributions can't.

"You can withdraw the contributions you made to a Roth IRA anytime, tax- and penalty-free," says Julia Vanzler, a private wealth advisor at SVB Private. "However, in order to take a tax- and penalty-free distribution from earnings, you must be 59½ and have waited at least five years after the first contribution."

Pulling out of those earnings — technically called a distribution — prior to the five-year mark or the day you turn 59½ will result in a 10% penalty.

3. There are no required minimum distributions

If you don't immediately need your Roth funds while in retirement, there's another perk: You don't have to.

With a traditional IRA, you must take required minimum distributions from your account at a certain point — technically by April 1 the year after you turn 72. This is also when you'll need to pay taxes on those distributions.

Roth IRAs, on the other hand, have no required minimum distributions. You can keep the funds growing in your account until you need them.

4. You can pass down assets tax-free to heirs

You can also use Roth IRAs to provide for your dependents if you pass away. Should that happen, your heirs can withdraw from the account without owing an additional tax on the amount.

According to Phillip Weiss, a financial advisor at Apprise Wealth Management, this can be particularly beneficial to any spouse you may leave behind.

"The tax-free aspect of Roth IRA withdrawals also provides benefits to your surviving spouse — who likely will have a higher tax rate when taxed as a single rather than a married filer," Weiss says.

5. They can help you avoid higher taxes during retirement

Because Roth IRA withdrawals aren't taxed in retirement, they could help you pay fewer taxes in the long run — particularly if you expect to be in a higher income tax bracket once you retire.

"If you think tax rates will go up over time or expect to be in a higher tax bracket in the future, then paying taxes now is likely to save you money," says Jay Zigmont, a certified financial planner and founder of Childfree Wealth.

This approach can often be helpful for younger workers who aren't making much and are taxed at much lower rates than they will be later in their careers. Currently, someone making between $11,000 and $44,725 pays a 12% tax rate. Once their earnings surpass $44,725, it jumps to 22%.

6. They can complement other retirement efforts

Roth IRAs don't have to be your one and only retirement account. In fact, experts say they're actually a great complement to other account types, especially if you have employer-sponsored options, like a 401(k).

"Probably the best way to accumulate funds for retirement is to take advantage of IRAs and employer retirement plans," Rosenstrock says. "It doesn't matter if you're covered by an employer's retirement plan, such as a 401(k) or 403(b). As long as you don't exceed the IRS's income limits, you can still contribute the maximum annual amount to a Roth IRA."

For 2024, that maximum is $7,000 for most taxpayers and $8,000 if you're over the age of 50.

What are the drawbacks of a Roth IRA?

Roth IRAs have many advantages when compared with other types of retirement accounts, but they aren't perfect.

For one, they have income caps. As Rosenstrock explains: "High-income professionals do not qualify to make Roth contributions."

For 2024, if you make more than $161,000 and file your taxes as a single or head of household, you cannot make any contributions to a Roth IRA. The same goes for married couples making $240,000 and filing jointly. If you're married, live together, and file your returns separately, the cap is $10,000.

In 2023, the max for single persons or heads of households was $153,000 and $228,000 for married couples filing jointly.

Another drawback of Roth IRAs is their lack of tax deductions.

"There are no current-year tax benefits for Roth IRAs as there are with many other types of retirement accounts," Rosenstrock says. "So these accounts don't serve to reduce your upfront taxes like other retirement accounts do."

How to open a Roth IRA

If you're ready to open a Roth IRA, you'll need to choose the brokerage or investment firm you want to work with. When weighing your options, make sure to consider fees, service, account minimums, and other factors.

See Insider's picks for the best online brokers >>

Once you choose and fill out the institution's required paperwork, you can fund your account and start picking investments. You can invest your Roth IRA funds into all sorts of assets, including mutual funds, ETFs, money market funds, stocks, and more.

The bottom line

Roth IRAs can be a smart way to save up for retirement and avoid high tax bills later on in life. Keep in mind, though, they can also be used in tandem with other retirement accounts, including 401(k) and traditional IRAs.

If you're considering opening a Roth IRA, talk to a financial advisor first. They can help you devise the best strategy to maximize your wealth and minimize your tax burden.