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What Is a Roth IRA?

A Roth IRA is an individual retirement account funded with after-tax dollars. You can’t deduct contributions to a Roth IRA at tax time, but you can withdraw your money tax-free in retirement. A Roth IRA is a popular choice for young people just starting out in their careers. Want to know more about this retirement strategy? You’ve come to the right place. We’ll give you the run-down.

Roth IRA Pros and Cons

These days, people who want to save for retirement have many choices as to where they park their dollars. One popular retirement investment vehicle is the Roth IRA. You fund a Roth IRA with after-tax dollars and don’t deduct your contributions when you file your tax returns. That’s good news and bad news, depending on how you look at it. The bad news is that you don’t get a tax break now. The good news is that you get a more valuable tax break down the road (aka after you turn 59 1/2). Why? Because you won’t have to pay income tax on either the money you originally contributed or the money you’ve earned over years in the market.

The younger you are, the more you stand to gain from opening a Roth as part of your retirement savings plan. Any money you contribute now will have more years of compounding and growth. That means you’re getting a bigger tax break when you start taking distributions in retirement than you would if you opened a Roth at age 50.

Another advantage of the Roth is that it doesn’t come with Required Minimum Distributions (RMD)s while the owner of the account is alive. That means you don’t have to start taking money out of your Roth IRA when you hit age 70 1/2, as you would with a traditional IRA.

Depending on your circumstances, the lack of RMDs could be a big advantage. If you’re already getting enough income from a combination of Social Security and a 401(k), having a regular IRA would require you to take distributions that could push you into a bigger tax bracket. With a Roth IRA, you won’t run into the problem of having to take money you don’t need only to be slammed with a bigger tax bill.

Roth IRA Eligibility

What Is a Roth IRA?

Roth IRAs were not designed for wealthy savers. In fact, there is an income cap on Roth IRA eligibility. The IRS income rules for Roth IRAs use your Adjusted Gross Income (AGI) as a guide. Your AGI is simply the total of all your taxable income, minus certain qualified deductions such as those for medical expenses and unreimbursed business expenses.

The IRS sets an income eligibility range that tells you whether you can make a) the maximum contribution to a Roth IRA ($6,000 for tax year 2019 and 2020), b) a partial contribution or c) no contribution. For 2020, the AGI phase-out range for a married couple filing jointly is $196,000-$206,000. For those filing singly, the range is $124,000 to $139,000.

If your income falls below the bottom of the range, you can contribute the full $6,000 to a Roth IRA. If it’s within the range, you are subject to contribution phase-out rules, meaning that you won’t be able to contribute the full $6,000. If your income is above the top of the phase-out range, IRS rules prohibit you from contributing to a Roth IRA.

The Backdoor Roth

Too rich for a Roth? There’s a workaround called the “backdoor Roth” that lets you take advantage of the tax benefits of a Roth IRA. Say you’re doing well for yourself financially. You have a 401(k) through your employer, but you’re hankering after a Roth so you can diversify your tax burden in retirement. If your income means you’re ineligible to open a Roth directly, you can still open a backdoor Roth.

If you’re in a high income bracket and saving through your 401(k) at work, you won’t be able to fund a deductible traditional IRA. But you can still open a non-deductible traditional IRA and then convert that traditional IRA to a Roth IRA. And just like that, you have a Roth. Sneaky, right?

If you want to take advantage of a backdoor Roth, act fast. The government has its eye on the backdoor Roth as one of several tax loopholes to close. The backdoor Roth is popular, so it may survive efforts to eliminate it.

The Takeaway

Having a Roth IRA in your financial arsenal gives you more flexibility in retirement. You don’t have to take (and pay taxes on) Required Minimum Distributions if you don’t want to. And did we mention that any money you do take out of your Roth IRA  (that is a qualified distribution) is completely free from federal taxes?

If you are tempted to open a Roth IRA, it’s important to look for a provider offering low fees. Higher fees mean less money for you and more money for the financial institution hosting your investments. Fees can cost investors tens of thousands of dollars over the course of their working years, so it pays to shop around and get the best deal you can.

Tips for Getting Retirement Ready

  • Figure out how much you need to save to retire comfortably. An easy way to get ahead on saving for retirement is by taking advantage of employer 401(k) matching.
  • Work with a financial advisor. According to industry experts, people who work with a financial advisor are twice as likely to be on track to meet their retirement goals. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

Photo credit: ©iStock.com/Milan Marjanovic, ©iStock.com/gpointstudio

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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