Should You Open a Roth IRA?

Consider your future income first

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A Roth IRA is an individual retirement account where your money can grow tax-free. You contribute after-tax dollars and can withdraw your money without paying any taxes on the earnings, as long as you meet certain rules, including that you’re at least age 59 ½ when you withdraw. Roth IRAs are a popular retirement investing tool, especially because you can open one in addition to a workplace 401(k). But a Roth IRA isn’t your only option for retirement savings.

Another popular account is a traditional IRA, which allows you to contribute pre-tax dollars, and then pay taxes on your contributions and earnings when you withdraw the funds in retirement. With a traditional IRA, you’ll be required to withdraw a certain amount of money once you reach age 72, but a Roth IRA doesn’t have this requirement. 

While Roth IRAs have many advantages, they also have some limitations. Before you decide whether to open a Roth IRA, it’s important to fully understand what makes a Roth IRA a good retirement option—and when you might be better off with a different account. 

Key Takeaways

  • You can invest $6,000 ($7,000 if you’re 50 or older) in a Roth IRA in 2022, the maximum amount, if you make under $129,000 as a single person or $204,000 if you are married and filed jointly.
  • You do not have to pay taxes when you withdraw money from a Roth IRA, assuming you’ve had the account for five years and you're 59 ½ or more among other rules. 
  • There are limitations to a Roth IRA, such as low contribution limits and withdrawal penalties before the age of 59 ½. 

What Makes a Roth IRA a Good Retirement Option?

Understanding the advantages of a Roth IRA can help you evaluate whether it’s a good fit for your retirement savings.

Tax-Free Investment Growth

Roth IRA contributions are made with after-tax dollars and your contributions and earnings on those contributions can grow tax-free. That means when you withdraw the money in retirement, you won’t have to pay taxes or penalties on that money, as long as you meet the requirements for a qualified distribution.

Choosing a Roth IRA can be especially advantageous if you’re in a low tax bracket when you make your contributions and in a higher tax bracket in retirement. Not having to pay that higher tax rate on your contributions and earnings could save you a lot of money compared to investments in other kinds of retirement accounts.

Withdrawal Flexibility

Many other retirement accounts have required minimum distributions (RMDs), which are mandatory withdrawals that begin when you reach age 72. However, a Roth IRA does not have RMDs, so you can leave your money in the account longer, allowing it to continue to grow. 

You can withdraw your contributions at any time, and once you reach age 59 ½, you can also withdraw your earnings tax-free. If you’re younger than age 59 ½, you can withdraw tax-free earnings as long as you use them for specific expenses, such as to purchase your first home or to pay for qualified education expenses.

If you withdraw any money from a Roth IRA that’s less than five years old, you may be required to pay taxes on the earnings. If you’re younger than 59 ½, you may also pay an early withdrawal penalty unless you qualify for an exception.

Indefinite Contributions

As long as you’ve earned income, such as a salary, tips, or professional fees, you can continue contributing to a Roth IRA indefinitely. For example, doing occasional consulting work or working a part-time job would allow you to continue to contribute to your Roth IRA past the age of 70 ½. This may enable you to earn more money to use later on in retirement. (This was a benefit of Roth IRAs over traditional IRAs until the SECURE Act scrapped the contribution age limit of 70 ½ for traditional IRAs starting January 2020.)

Tax-Free Money for Heirs

Upon death, any money left over in a Roth IRA is not taxable, provided the original owner—in this case you—has held the account for at least five years. Beneficiaries, however, must take a required minimum distribution (RMD) after your death, but rules about the RMD differ depending on whether the beneficiary is a spouse or someone else. A surviving spouse can designate themself as the account owner, roll over the account into a traditional IRA or qualified employer plan, or become the beneficiary of the IRA. 

You Can Invest Even If You Have a 401(k)

Provided that you meet income requirements, you can contribute the maximum amount to a Roth IRA in addition to any money you put into a workplace 401(k). You may want to invest in both if you have the ability and want to contribute additional income to retirement.

Limitations of Roth IRAs

While a Roth IRA has many features that make it a good investment option, it also has some limitations.

Low Contribution Limits

There is a maximum limit of $6,000 ($7,000 if you are age 50 or older) that you can contribute to IRAs in 2022. This means that your total contribution to all your IRAs (traditional and Roth) combined cannot exceed that amount. This limit is considerably less than a traditional (or Roth) 401(k) plan offered by many employers, which has a maximum contribution amount of $20,500 in 2022 ($27,000 for those aged 50+).

Any IRA contributions in excess of the annual limit are subject to a 6% penalty for every year they remain in the account. If you do contribute too much, you should withdraw the excess contributions and any earnings on them by the time your tax returns are due to avoid the penalty.

Income Limitations

Not everyone is able to contribute to a Roth IRA. You must be earning income and be under an income threshold based upon your modified adjusted gross income (MAGI). Your filing status and income level will also determine if you’re eligible to contribute fully or partially towards the annual Roth IRA contribution limit. 

For example, if you file your taxes as a single person or head of household, you cannot contribute the full contribution amount to a Roth IRA if you earn more than $129,000. If you earn between $129,000 and $144,000, you can still contribute to a Roth IRA, but at a reduced rate. 

These thresholds are higher for married individuals filing jointly. If together you earn up to $204,000 or less, you can contribute the full amount; you’re limited to contributing a reduced amount if your joint MAGI is between $204,000 and $214,000. Those who earn above the income thresholds of $144,000 as a single person or $214,000 if married and filing taxes jointly cannot contribute to a Roth IRA plan.

The Downside of After-Tax Contributions

If you open a Roth IRA, you pay taxes up front on the money you use to fund it. But there is a downside to this: You may be overpaying for taxes if you end up being in a lower tax bracket when you retire.

If you are in prime earning years and are in the 24% marginal tax bracket, which is the highest tax bracket that an individual could be in and still able to contribute to a Roth IRA, you may pay more in taxes with a Roth IRA than if you opened a pre-tax retirement account, like a traditional 401(k). 

Choosing between a Roth IRA and a pre-tax retirement account essentially is a choice of when you decide to pay taxes—now with a Roth IRA versus in retirement with a pre-tax account.

A traditional 401(k) may make sense for a higher earner, as you would pay taxes in retirement upon withdrawal, when you likely will be in a lower tax bracket. This is a difficult assessment to make, however, as you do not fully know what your income and tax bracket will be when you retire. Also, you do not know if the federal government will raise taxes before then.

Withdrawal Penalties If You Remove Earnings Before 59 ½ 

If you want to withdraw earnings from a Roth IRA account before the age of 59 ½, you have to pay a 10% early withdrawal penalty. There are some exceptions that allow you to avoid the 10% withdrawal penalty, such as using funds for college expenses, birth of a child, or a disability. There is also a similar age withdrawal penalty for a traditional IRA and 401(k).

While early distribution of earnings may be subject to a penalty, the money you contribute to a Roth IRA can always be withdrawn tax-free and penalty-free, even before the age of 59 ½.

Opening a Roth IRA: Should You Do It?

You should open a Roth IRA if the advantages outweigh the disadvantages for your financial situation. For example, if you are not offered a workplace 401(k), then finding a tax-advantaged way to save for retirement, like a Roth IRA, will likely make sense if your income is below the income threshold for Roth IRA eligibility.  

Having a 401(k) doesn’t necessarily mean that you shouldn’t open a Roth IRA account. While Roth IRAs offer tax-free distributions in retirement, if your employer offers to match your contributions to a 401(k), that’s a powerful benefit. You may want to max out the employer match amount for the 401(k) before you contribute to a Roth. If you have the ability to save more money, you could set money aside in both Roth IRA and 401(k) to get the best of both worlds.

Compared to a traditional IRA, a Roth IRA offers a greater degree of flexibility. There are no RMDs in a Roth IRA and you can withdraw your contributions penalty-free and tax-free at any time. In contrast, a traditional IRA mandates RMDs after age 72 and taxes must be paid at withdrawal for any tax-deductible contributions made into the account.

However, if you think you need access to money before age 59 ½, there may be another option that offers greater liquidity at the cost of a less advantageous tax treatment. Compared to a Roth IRA, a brokerage account doesn’t levy a 10% early withdrawal penalty on earnings, but it also does not offer tax benefits.

Frequently Asked Questions (FAQs)

How do you open a Roth IRA?

You can open a Roth IRA at a bank, credit union, or investment brokerage. When you open a Roth IRA, you may choose to either have this account professionally managed by an actual person, an automated computer advisor (called a robo-advisor), or you can choose to manage your own investments.

How much interest does a Roth IRA earn?

A Roth IRA does not have a set interest rate that you earn each year. You earn money in a Roth IRA account by picking your investments, or letting a professional or robo-advisor choose for you.  Your investment choices and their performance over time will determine how much money your contributions earn.

How much should I contribute to my Roth IRA?

How much you decide to contribute to a Roth IRA  depends on many factors like your income, filing status and how much you are saving in all of your retirement accounts. In 2022, you are able to contribute up to $6,000 per year across all IRA accounts ($7,000 if you’re 50 years old or older). Contributing the maximum amount to a Roth IRA provides a lot of flexibility, as all contributions can be withdrawn at any time tax- and penalty-free.

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