Tax-advantaged accounts were created to incentivize saving for retirement. A Roth IRA is a unique type of account known as a tax-exempt account. However, “tax-exempt” doesn’t mean a Roth IRA is a tax-free investment vehicle. You still pay taxes on the money you put into the account, but when you withdraw, you will not pay taxes on the withdrawn amount, nor any gains you’ve earned from it.

What is a Roth IRA?

A Roth IRA is a retirement savings account that allows you to contribute money after you’ve paid tax on it, not before. That is, you pay income tax on contributions when they’re made, not when they’re withdrawn in retirement.

Eligible individuals may open a Roth IRA either with a brokerage or a robo-advisor. Once your Roth IRA is open, you can then choose your own investment strategy. With a brokerage account, you’ll choose how to invest your money. A managed investment account or robo-advisor will determine the investment strategy for the money in your Roth IRA on your behalf.

Roth IRA eligibility requirements & income limits

You must meet certain eligibility requirements to open and contribute to a Roth IRA account. In addition to having earned income, you must meet the income requirements.

Here are the 2023 Roth IRA income limits, using modified adjusted gross income:

• Single taxpayers: less than $138,000 for maximum contribution
• Married filing jointly: less than $218,000 for maximum contribution
  

You may still qualify to make smaller contributions if your income is less than $153,000 for single filers and less than $228,000 for married taxpayers filing jointly.

The maximum Roth IRA contribution limit for 2023 is $6,500. You may contribute an additional $1,000 each year (for a total of $7,500) once you reach 50 years old.

The contribution limits apply individually. If you’re a married couple that meets the eligibility requirements, you may each open your own Roth IRA and contribute up to $6,500, for a total of $13,000 in annual contributions. At least one spouse must earn income. If one spouse does not earn any income, they may open a spousal Roth IRA in their name.

How does a Roth IRA work?

Money deposited into your Roth account comes from after-tax income, so don't expect to take a deduction when it’s time to file your return.

The expectation is that the investments made with your Roth IRA will appreciate in value over time. Because you already paid income tax on the initial contributions, you do not have to pay any taxes on the earnings.

Roth IRA distributions

Roth IRA distributions are allowed tax-free and penalty-free when the account holder is at least 59 ½ years old and has owned the account for at least five years. Early withdrawals usually result in a 10% penalty as well as having to pay income tax on the money withdrawn. However, once you qualify, you can withdraw from the account without having to pay taxes or the penalty.

There are some exceptions for tapping into your earnings without penalty or tax consequences, as long as the funds are used for specific reasons, including:

• Buying your first home ($10,000 limit)
• Adopting a child ($5,000 limit)
• Paying for qualified education expenses
• Using funds because of disability
• Paying for health insurance premiums during unemployment
• Paying an IRS levy
  

There are no required minimum distributions with a Roth IRA as there are with other types of retirement accounts such as traditional IRAs and 401(k)s. Even if you reach a certain age during retirement, you can let those investments grow as long as you’d like without having to take withdrawals on a specific schedule.

Roth IRA vs. traditional IRA

There are several differences to note when comparing a traditional IRA vs. a Roth IRA.

• Tax advantage:

  A Roth IRA and traditional IRA each has its own unique tax advantage. A Roth IRA doesn’t offer a tax deduction on contributions, but all earnings are tax-free on eligible withdrawals. A traditional IRA, on the other hand, lowers your taxable income when you contribute, but you must pay income tax on your withdrawals in retirement.

• Income limits:

  Not everyone can open a Roth IRA. You must meet the income limits to qualify. There are no income limits with a traditional IRA. However, there are income limits on the tax deduction for a traditional IRA if you also have access to a workplace retirement plan (like an IRA).  

• Required minimum distributions (RMDs):

  Since you don’t have to pay taxes on your Roth IRA withdrawals, the government does not require you to take mandatory distributions at any time. With a traditional IRA, however, you must begin taking withdrawals once you reach age 72.
  

If you’re eligible for both a Roth IRA and a traditional IRA, the benefits primarily come down to when you want to take advantage of those tax savings—now, or during retirement.

Roth IRA vs. 401(k)

One item to note when comparing a Roth IRA to a 401(k) is that you can contribute to both, as long as you meet the eligibility requirements for a Roth IRA. Having a 401(k) impacts your ability to qualify for a tax deduction with a traditional IRA, but this rule doesn’t apply to a Roth IRA.

In contrast to a Roth IRA, a 401(k) comes with the same tax treatment as a traditional IRA. You get a tax deduction on your contributions, then pay income taxes when it comes time to take a withdrawal. Some employers offer matching contributions on employee 401(k)s up to a certain limit.

Finally, 401(k)s also come with a required minimum distribution, whereas a Roth IRA does not.

The bottom line

A Roth IRA is an investment tool that can help you save for retirement, with a reduced tax burden when you withdraw during retirement. The biggest constraint is qualifying under the income limits.‍