A Roth individual retirement account (IRA) allows savers to build wealth now while enjoying tax advantages later. Roth IRAs are funded with after-tax dollars, and qualified withdrawals are tax-free. There are no required minimum distributions (RMDs), so you can continue adding to your Roth IRA balance as long as you're earning income.
Generally, the best time to open a Roth IRA is when you're younger, since you're more likely to be eligible based on your income. Getting an early start with a Roth IRA also means you have more time to capitalize on the power of compound interest. But there are also other times when opening a Roth retirement account can make sense.
- A Roth IRA is a tax-advantaged retirement savings account allowing for tax-free qualified distributions (withdrawals of earnings).
- Tax filing status and modified adjusted gross income (MAGI) limits determine whether you can fund a Roth IRA.
- The best time to open a Roth IRA is usually when you're young and have a longer time horizon to invest for retirement.
- There are no age limits for opening a Roth IRA; you can open one at any age, as long as you have earned income.
How a Roth IRA Works
A Roth IRA is an individual retirement account you can open in addition to or within a workplace retirement plan. Roth IRAs allow savers to contribute money up to an annual contribution limit. Those contributions are made using already-taxed dollars, so qualified withdrawals from a Roth IRA are tax-free.
Roth IRAs have some features that set them apart from traditional IRAs. Here's are some differences:
|Roth IRA||Traditional IRA|
|Contributions aren’t tax-deductible.||Contributions are tax-deductible.|
|There are no required minimum distributions and no age limits for contributions.||Require minimum distributions must be made after age 72.|
|Qualified withdrawals are tax-free.||You must pay tax on the deductible contributions you made at the time of withdrawal.|
|Income determines how much you can contribute toward the annual contribution limit.||Only annual contribution limits apply.|
The IRS establishes the maximum annual contribution limit for all your IRA contributions—and that means both traditional and Roth. For the 2022 tax year, this limit is $6,000. Those age 50 or older can make an additional $1,000 catch-up contribution, for a total of $7,000. Your income and filing status determines whether you can make the full contribution.
Parents can open a custodial Roth IRA for kids under age 18, as long as their child has earned their own income.
The Best Time To Open and Fund a Roth IRA
In general, the best time to open a Roth IRA is when you're eligible to do so, based on your income and filing status, and you have extra money to save. Here are some other things to consider when deciding if the time is right to open a Roth for retirement.
You Have Earned Income
The IRS requires you to have compensation or earned income to open a Roth IRA. Examples of acceptable income sources include:
- Earnings from self-employment
If you have a 9-to-5 job that gives you a regular paycheck, that will count as earned income. But you could also qualify for a Roth IRA if you make money from side hustles or a business you own.
Keep in mind that certain types of income aren’t Roth IRA eligible. For example, you can't open a Roth if your only source of income is interest and dividend income, or pension income.
If you're married and have earned income but your spouse doesn't work, you could open a spousal IRA on their behalf.
You’ve Met Your Employer Match
If you have a 401(k) plan at work, you could still open an additional Roth IRA. However, the best time to open a Roth IRA might be after you've maxed out your workplace plan contributions for the year and still have money to save. After all, your 401(k) contributions are deducted from taxable income and lower your annual tax liability; maxing out your plan can help you get the full employer match if one is offered.
If you’ve hit the limit in your 401(k) or just your employer match, you could open a Roth IRA to take advantage of future tax savings. You may also find that a Roth IRA has different or more investment options available, or you just want to diversify your investment buckets.
For the tax year 2022, the regular annual 401(k) contribution limit is $20,500. The extra catch-up contribution amount is $6,500 for savers age 50 and older.
One of the best reasons to open a Roth IRA when you're young is to cash in on your investments' compound interest and earnings. Compounding helps grow wealth over time, and the longer you have to save, the better.
Here's an example of how powerful compound interest in a Roth IRA can be. Say you open a Roth IRA at age 25 and contribute $6,000 a year (or $600/month) until age 65. Your money earns a 7% annual rate of return over 40 years. You'd have just under $1.3 million for retirement at that savings rate.
But what if you wait until age 35 to open a Roth IRA? In that case, you'd end up with around $612,000 saved instead, over 30 years. That's a significant amount of money you've cost yourself by waiting to open a Roth IRA.
You could visualize investment scenarios over different time horizons using tools such as a compound interest calculator.
Your Income Is Lower
Roth IRAs allow for tax-free distributions in retirement. If you anticipate your retirement-age income being higher than at present, now could be an excellent time to open a Roth IRA.
Contributing now may also decrease any worries about being eligible for a Roth IRA contribution if your income advances along with your career. Once your income reaches certain thresholds, your ability to save in a Roth IRA phases out. For 2022, you can't contribute to a Roth IRA if your modified adjusted gross income (MAGI) is:
- Greater than or equal to $144,000 and you file single, head of household, or married filing separately, and you did not live with your spouse during the year.
- Greater than or equal to $214,000, and you're a married couple filing jointly, or a qualifying widow(er).
You may also only be able to contribute a reduced amount once you hit a specific MAGI limit. For example, a married couple filing jointly can only contribute a reduced amount to their Roth IRA if the MAGI is over $204,000 and below $214,000.
Opening an IRA when your income is low may qualify you for the Retirement Saver's Credit of up to $1,000 for single filers and $2,000 for married filing jointly. Qualifying for the 2022 year requires very low income levels:
- Head of household: AGI of less than $51,000
- Married jointly: AGI of less than $68,000
- All other filers: AGI of less than $34,000
If you're married and file separate returns but lived together during the year, you can't contribute anything to a Roth IRA if your income is higher than or equal to $10,000.
Your Federal Tax Rates Are Low
Federal tax rates are not set in stone, and there's no way to gauge exactly when tax laws will change. Opening a Roth IRA while tax rates are low can help build some protection against potentially higher taxes later.
For example, the 2017 Tax Cuts and Jobs Act lowered tax rates for most taxpayers from 2018 through 2025. But many of the provisions will expire in 2025, which could lead to higher tax rates for most taxpayers, according to the independent nonprofit Tax Foundation. Putting money in now that you can withdraw tax-free in a higher-tax-rate future could be wise.
Consider Converting to a Roth IRA When Your Income Drops
You may be already saving for retirement in a traditional IRA. But if your income drops (along with your tax rate), you could convert your savings to enjoy the future tax benefits of a Roth IRA, while potentially paying less on the conversion’s taxes now.
With a Roth IRA conversion, you're moving money from a traditional IRA to a new Roth IRA. You can request a direct transfer, in which your traditional IRA custodian moves the money on your behalf, or roll over the money yourself. Since traditional IRAs are funded with pretax dollars, you'd owe tax on the amount you convert—but you'd be able to make qualified distributions from your Roth IRA in retirement.
Say you have $100,000 saved in a traditional IRA. You want to convert that amount to a Roth IRA. Your IRA custodian either transfers the money for you, or you roll over the distribution within 60 days. The custodian issues a Form 1099-R, which you'd file with your taxes.
You’ll pay taxes on your deductible contributions and gains, which you would need to pay with non-IRA funds; taking early distributions from your IRA could be subject to a 10% early withdrawal penalty if you're under age 59½, on top of the income tax.
Roth IRA conversions can temporarily increase your tax liability in the year they occur. However, it could be worth it to convert traditional IRA assets if your income has dropped to a level that makes a Roth IRA conversion more attractive or doable.
Roth IRA conversions can be done in part or all at once. Consult with a tax professional on whether converting the entirety of an IRA to Roth might send you into a higher tax bracket.
Frequently Asked Questions (FAQs)
When is the best time of year to open a Roth IRA?
You have until the tax filing deadline each year to open a Roth IRA and make contributions for that tax year. So the best time of year to open a Roth IRA could be April if you're trying to score some last-minute tax benefits for the future.
How do you open a Roth IRA?
You can open a Roth IRA at a brokerage account online. You'll need to give the brokerage some personal information, including your name, date of birth, and Social Security number. You'll also need to provide a funding source for making contributions. Once your Roth IRA is open, you can begin choosing your investments.
How much can you contribute to a Roth IRA?
For 2022, the maximum annual contribution to a Roth IRA is $6,000. An additional catch-up contribution of $1,000 is available for savers age 50 and older.
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IRS. "Roth IRAs."
IRS. “Traditional and Roth IRAs.”
Tax Foundation. "A Look Ahead at Expiring Tax Provisions."
IRS. “IRA FAQs.”