A Roth IRA is a type of account where you put money in, let it grow without paying taxes on it each year, and if you meet the rules, then the money comes out tax-free. If you are familiar with a Traditional IRA, it is basically the opposite.
With a Traditional IRA you may get a tax deduction on the way in, which means its taxable on the way out. With a Roth IRA, there is no tax deduction on the way in, but all the money on the way out can be tax-free.
Remember that the “Roth IRA” is just a government title for a specific way an account is taxed. After deciding upon a Roth IRA account, you still need to choose an investment provider, and specific investments inside of that Roth IRA.
You might think you can’t have both a Roth IRA and a Roth 401(k). Those are completely separate accounts with different rules. You can have a Roth IRA, and put in its max, and a Roth 401(k) and put in that max.
Please use this decision process to help you determine if a Roth IRA is best for you:
Are you contributing enough into your 401(k) to get the employer match?
Do you believe your taxes in the future will be higher than your taxes today?
Will you need the money after age 59.5? Or perhaps are you going to take the money out to help purchase your first home?
If you answered yes to all of those questions, then a Roth IRA is probably right for you.
Remember that you must still choose a trustworthy investment provider and investments that make sense for you. Be sure to choose based on when you want to take them out and how much risk you are willing to take. You may contribute up to the max in both your Roth IRA and Roth 401(k). Between you and your spouse, your income must be higher than the amount you put into the Roth (this could apply to students, or retirees especially).
There are limits to Roth IRA contributions. In 2021, the limit for Roth & Traditional IRAs is $6,000 (plus another $1,000 if over 50). This is per person. Your spouse may set up a Roth IRA, even if they have no income, as long as you have enough income for both of you. If you make higher income you may not be able to contribute. This begins at $198,000 for married and $125,000 for single taxpayers.
There are also limits to Roth & Traditional 401(k)s. In 2021, this limit is $19,500 (plus another $6,500 if over 50) per person. You may contribute to both an IRA and a 401(k). There is no limit on your income. You can make a LOT of money and still contribute to a 401(k).
A Roth IRA can be a great way to save for your future retirement income needs. Make sure to use our decision process above, and please visit the IRS Roth IRA website to learn all of the official rules.
Jeremy Keil, CFP®, CFA is a retirement focused financial planner with Keil Financial Partners, and host of the Retirement Revealed blog and podcast.