What Is a Roth IRA and How Does It Work?

If you’re thinking of opening a Roth IRA, you’ve probably got questions. What is a Roth IRA exactly, and how is it different from a traditional IRA? How does a Roth IRA work? Am I even eligible?

If you’ve got questions, that means you’re being intentional when it comes to your money. And that’s a good thing! You always want to learn everything you can about an investment (or in this case, an investment account) before you commit to putting your money into it.

So, let’s go over everything you need to know about a Roth IRA and why it’s a great way to start growing your retirement savings. Ready to jump in? Let’s do it.

What Is a Roth IRA?

A Roth IRA (aka Individual Retirement Account) is a retirement account that lets you save up to a certain amount each year for retirement. It really is the rock star of retirement accounts! Roth IRAs are easy to set up, simple to maintain, and come with tax advantages that help you build wealth and boost your retirement savings over the long haul.

In fact, we’re big fans of a Roth IRA because of those tax advantages—they’re the main difference between a Roth IRA and a traditional IRA. While a Roth IRA doesn’t offer any current-year tax benefits like a traditional IRA, it gives you something even better: tax-free growth and tax-free withdrawals once you retire. Now, that’s a sweet deal!

 

How Does a Roth IRA Work?

A Roth IRA is an after-tax investment account. That means when you put money into your Roth IRA, you’ve already paid taxes on it. Why is that important? Because it means you won’t pay any taxes on that money in retirement. And all the growth on your contributions will be tax-free too.

That’s a huge deal, worth repeating: Any withdrawals you make after age 59 1/2 are tax-free, as long as you’ve had the account more than five years.⁵ More on that five-year rule in a bit.

Before we get into the details, keep a couple of things in mind. First of all, a Roth IRA isn’t an investment in itself—think of it as an umbrella that covers your investments and protects them from taxes. You can put all kinds of different investments into your Roth IRA.

The second thing to remember is that a Roth IRA is separate from your employer-sponsored retirement savings plan. Some employers offer Roth 401(k) plans. You can learn about the difference between a Roth IRA and a Roth 401(k) in the FAQ section at the end of the article.

What Are the Benefits of a Roth IRA?

Here’s a quick breakdown of why we’re such fans of a Roth IRA:  

• You can contribute at any age as long as you meet income requirements.
• Your contributions and growth are tax-free.
• You won’t have to pay taxes when you start withdrawals at retirement.
• You’re not required to take distributions at a certain age, unlike the traditional IRA (which requires withdrawals starting at age 73).⁶ 
• You can keep contributing to your Roth IRA if you choose to work past retirement age, as long as your income still falls within the income limits we’ll discuss a little later. 
• You can choose beneficiaries to inherit your Roth IRA, and they’ll be able to use the money in the account tax-free too.

2024 Roth IRA Contribution Limits

You knew there had to be a catch! Unfortunately, Uncle Sam says you can’t just put as much money as you want into an IRA. For 2024, the total amount you can contribute to either a Roth IRA or a traditional IRA is $7,000 ($8,000 if you’re 50 or older).⁷

Market chaos, inflation, your future—work with a pro to navigate this stuff.

If you’re considering rolling over your 401(k) to a Roth IRA, though, we have good news! Rolling over your money doesn’t count toward your contribution limit. Just be sure to check with your financial advisor about how rolling over your retirement fund can affect taxes. 

Am I Eligible to Open a Roth IRA?

This one’s easy, folks. If you earn income and it’s less than the Roth income requirements, which we’ll cover right below, then you’re eligible.

But you can’t contribute more than you make. So, if your 19-year-old son or daughter earned $3,000 waiting tables over the summer, they can only contribute up to $3,000 to a Roth IRA.⁸

Another perk: There are no age restrictions with Roth IRAs. Whether you’re 17 years old or you just turned 92, you can contribute to your account as long as you’re earning an income.

2024 Roth IRA Income Limits

A Roth IRA offers some great tax benefits, but those benefits aren’t available for everyone. Once your income reaches a certain amount, you’ll either have to contribute a reduced amount or not contribute at all.

Here’s how the 2024 Roth IRA income limits and contribution limits play out:

Filing Status	Roth IRA Income Limits	Roth IRA Contribution Limits
Single or Head of Household	Less than $146,000	$7,000 (8,000 if age 50 or older)
	More than $146,000 but less than $161,000	Contribution is gradually reduced
	$161,000 or more	No contribution allowed
Married, Filing Jointly or Qualifying Widow(er)	Less than $230,000	$7,000 ($8,000 of age 50 or older)
	More than $230,000 but less than $240,000	Contribution is gradually reduced
	$240,000 or more	No contribution allowed9

If your income exceeds the Roth IRA eligibility limits, good for you—but bad for your ability to open a Roth IRA. You won’t be able to stash your cash in a Roth, but a traditional IRA might be an option. Tax benefits for traditional IRAs have different eligibility requirements, so check with an investing pro to see if it’s a good choice for you.

If you’re self-employed, here’s another option: Establish a Simplified Employee Pension Plan (SEP) or a solo 401(k). Or if you run a small company with employees, consider a SIMPLE IRA that’ll allow you and your team members to save for retirement.

Roth IRA vs. Traditional IRA

While both types of IRA help people save for retirement, the main difference between a Roth IRA and a traditional IRA is how they’re taxed. We’ve touched on this already, but let’s recap:

• Roth IRA: Funded with after-tax dollars, which means your investments grow tax-free—and you can use the money in your Roth IRA tax-free when you retire.
• Traditional IRA: Funded with pretax money—so you get a tax break now, but you’ll have to pay taxes on any money you withdraw in retirement, including all the growth on your contributions.

Another major difference is income limits.

• Traditional IRA: No income limits—you can contribute no matter how high your annual income is.
• Roth IRA: For 2024, you can contribute up to the maximum amount if your gross income is less than $146,000 for single and head of household filers, and less than $230,000 for married couples filing jointly.¹⁰

And what about withdrawals? This is another way the Roth account comes out on top for most people.

• Roth IRA: You aren’t taxed on withdrawals in retirement, and there are no mandatory withdrawals you have to take at a certain age. You can leave your money in a Roth IRA as long as you want before you start making withdrawals.
• Traditional IRA: You have to make annual withdrawals after you turn 73.¹¹ And on top of that, you’ll be paying taxes on those withdrawals. Yuck!

How Much Can I Put in My Roth IRA Monthly?

We know the 2024 Roth IRA contribution limit is $7,000 for those under age 50, so figuring out how much you can contribute monthly is pretty simple. Just divide $7,000 by 12 months, and you get a monthly contribution of $583.33.

For those 50 or older, that contribution limit increases to $8,000, which comes to 12 monthly contributions of $666.67.

Roth IRA Withdrawal Rules

Okay, folks. We’ve covered the advantages of a Roth IRA, including the fact that you pay taxes on your contributions up front. And when it comes to early withdrawal rules, that can be good and bad news.

Here’s an overview of withdrawal rules for a Roth IRA before we get into the details.

If you are . . .	And you’ve held your Roth IRA for . . .	You can withdraw . . .
Under age 59 1/2	Less than 5 years	Contributions (without taxes or penalty) Earnings (subject to taxes and a 10% penalty)
Under age 59 1/2	5 years or longer	Contributions (without taxes or penalty) Earnings (subject to taxes and a 10% penalty)
Older than 59 1/2	Less than 5 years	Contributions (without taxes or penalty) Earnings (subject to taxes)
Older than 59 1/2	5 years or longer	Contributions and earnings (without taxes or penalties) 12

The Five-Year Rule

If you’re older than age 59 1/2 and your Roth IRA has been open at least five years, you can withdraw money (contributions and growth) from your Roth IRA tax- and penalty-free. Sweet!

But if it’s been fewer than five years since you opened your Roth IRA, you will be subject to taxes on any earnings you withdraw.¹³

Roth IRA Beneficiary Rules

The rules for Roth IRA beneficiaries revolve around two factors: the beneficiary’s relationship to the original owner and the age of the Roth IRA account.

Before the SECURE Act was passed in 2019, any beneficiary, no matter what their relationship was to the original owner, could leave that money in the Roth IRA for as long as they wanted. No required minimum distributions (RMDs) to worry about.

But now only certain qualified beneficiaries can leave inherited funds in a Roth IRA for longer than 10 years after the original owner’s death:

• Spouse of the original owner
• Minor children of the original owner
• Anyone disabled or chronically ill
• Anyone not more than 10 years younger than the original owner (like a younger sister or brother)¹⁴

Any beneficiary who doesn’t meet these qualifications has to withdraw all funds within 10 years of the original owner’s death.¹⁵ So, what if your beneficiary is younger than 59 1/2? Will they be penalized for early withdrawal? No. That’s the good news.

The not-so-good news is, if your beneficiary takes a withdrawal from your Roth IRA and you had held that Roth IRA for less than five years, then the earnings will be subject to tax.¹⁶ That’s the five-year rule we discussed earlier coming back into play.

How to Open a Roth IRA

Now that we’ve gone over the nitty-gritty details, let’s get down to the practical stuff.

The best way to open a Roth IRA is with the help of an investment professional who will meet with you face-to-face. Before you meet with your investment pro, you’ll need to gather some information and fill out the application. Here’s what you’ll need:

• Your driver’s license or other form of photo identification
• Your Social Security number
• Your bank’s routing number and your checking or savings account number
• Your employer’s name and address

As part of the process of starting a Roth IRA, you’ll also choose a beneficiary (or beneficiaries) who’ll inherit your account if something happens to you. You’ll need their name, Social Security number and date of birth.

Next, just add money! You can open your Roth IRA with a lump sum up to the annual limit. Or you may choose to deduct a specific amount from your bank account each month. You can actually do both as long as you don’t go over the contribution limit for that year.

Get Started on a Roth IRA Today!

Opening a Roth IRA is as easy as opening a checking account. Simply contact an investment professional who can guide you through the set-up process.

If you don’t have a financial professional, reach out to a SmartVestor Pro in your area. They’re committed to helping you understand your options and make informed investing decisions for your future.

Find your SmartVestor Pro today!

Ramsey Solutions is a paid, non-client promoter of participating pros. 

This article provides general guidelines about investing topics. Your situation may be unique. To discuss a plan for your situation, connect with a SmartVestor Pro. Ramsey Solutions is a paid, non-client promoter of participating Pros.