What is a Roth IRA?
A Roth IRA (Individual Retirement Account) is a type of personal retirement plan.
A Roth IRA is a government title for a specific way an account is taxed. The government allows Roth IRAs to have certain tax benefits. With a Roth IRA, you contribute after-tax dollars, invest the funds, and allow the money to grow without paying taxes on it each year.
If you meet the certain requirements, you are able to withdraw the money tax-free. This is a huge benefit. As an example, if you are over the age of 59 ½, you can withdraw funds from the Roth IRA without paying taxes.
If you are familiar with a Traditional IRA, a Roth IRA is basically the opposite. With a Traditional IRA you may get a tax deduction when you contribute the funds, but the withdrawals are taxable. Traditional IRA contributions are pre-tax contributions. With a Roth IRA, there is no tax deduction for the contribution, but withdrawals can be tax-free. Roth IRA contributions are post-tax contributions.
After deciding upon a Roth IRA account, you still need to choose an investment provider, and specific investments inside of that Roth IRA.
Roth IRAs have contribution limits. For 2021, the contribution limit is $6,000 per year (plus another $1,000 if you are over the age of 50). The $6,000 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.
It is important to note that not everyone can contribute to a Roth IRA. The government limits contributions from those with higher incomes. This begins at $198,000 for married and $125,000 for single taxpayers.
Is a Roth IRA right for you? You can use this decision process to help you determine if a Roth IRA is best for you:
1. Are you contributing enough into your 401(k) to get the employer match?
2. Do you believe your taxes in the future will be higher than your taxes today (since Roth IRA contributions are post-tax)?
3. Will you need the money after age 59 ½?
If you answered yes to all of those questions then a Roth IRA is probably right for you.
If you get a Roth IRA, you must still choose a trustworthy investment provider, and investments that make sense for you, your risk tolerance, and your financial goals.
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.