A Roth IRA is a tax-advantaged individual retirement account where the account holder can contribute after-tax dollars. A significant upside to Roth IRAs is that all contributions and accumulated earnings grow tax-free. After the age of 59 1/2, Roth IRA investors can withdraw those tax-free funds. To access funds, Roth IRA holders must hold the account for at least five years.
“In other words, you pay taxes on money going into the Roth IRA account, and then all future withdrawals are tax-free,” said Miles McQuillen, assistant vice president for private wealth management at Gabelli Funds in Norwalk, Connecticut, in a message. “Therefore, the tax treatment in this plan is said to be favorable if you anticipate being in a higher tax bracket during the time of withdrawals. The contribution limit for a Roth IRA for 2024 will be $7,000 if you are under the age of 50 and $8,000 if you are 50 or older. Roth IRAs often offer a broader range of investment options than many 401(k) plans.”
Here’s how to set up a Roth IRA:
1. Make sure you qualify for a Roth IRA.
2. Know the differences between a traditional IRA and a Roth IRA.
3. Understand the advantages of a backdoor Roth IRA.
4. Know the Roth IRA withdrawal rules.
5. Avoid these mistakes when managing a Roth IRA.
Make Sure You Qualify for a Roth IRA
Qualifying for a Roth IRA depends on your income.
“If you are under a certain income threshold, you can qualify to contribute to a Roth IRA,” said John Foard, a certified financial planner and co-founder at Crown Advisors, a Charlotte, North Carolina-based wealth management firm, in a message. “However, if you make too much income, you won’t be able to contribute to a Roth IRA.”
According to Foard, the modified adjusted gross income, or MAGI, for single filers must be under $153,000 for tax year 2023 and $161,000 for tax year 2024 to contribute to a Roth IRA. If you’re married and file jointly, your MAGI must be under $228,000 for tax year 2023 and $240,000 for tax year 2024.
The deadline to contribute to a Roth IRA is typically the tax-filing deadline for the year in question. For tax year 2024, the deadline for making contributions is April 15, 2025.
“Having an IRA likely won’t allow you to get rich fast, but they are still great for putting away after-tax dollars every year,” Foard noted.
[Are You Too Old to Benefit From a Roth IRA?]
Know the Differences Between a Traditional IRA and a Roth IRA
Roth IRAs offer some variables compared to traditional IRAs, and retirement savers need to know them.
Unlike a traditional IRA, contributions to a Roth IRA are made with after-tax dollars.
“When you withdraw money from a Roth IRA during retirement, those withdrawals are tax-free,” McQuillen noted. “That includes both your contributions and any earnings your investments have generated. Therefore, if you anticipate you will be in a higher tax bracket during your withdrawal period, incurring the taxes now with a Roth IRA may be a more tax-effective retirement vehicle.”
Anyone with earned income can contribute to a regular IRA, regardless of age, but there are income limits on whether or not your contributions are deductible. “However, Roth IRAs also have income limits that may affect your eligibility to contribute based on your filing status and income level,” McQuillen said.
The decision between a traditional and Roth IRA often comes down to your current tax situation, income level and future financial goals.
“If you prefer a tax break now and meet the eligibility criteria, a traditional IRA might be the way to go,” McQuillen said. “On the other hand, if you’re looking for tax-free withdrawals in retirement and can meet the income requirements, a Roth IRA could be the perfect vehicle for you.”
[READ: How Roth IRA Taxes Work]
Understand the Advantages of a Backdoor Roth IRA
You cannot contribute directly to a Roth IRA if you’re above the income limit. But you can still use a backdoor strategy.
“With the backdoor Roth IRA strategy, you contribute the money to a traditional IRA, then immediately convert that to a Roth IRA,” said Kendall Meade, a certified financial planner and financial therapist with SoFi in Charleston, South Carolina, in an email. “As long as the money has not been invested in the interim, there are no tax consequences.”
“There are no maximums or minimums for the amount you are allowed to convert, and you can spread out your conversion amounts over a series of years,” Foard said.
This tactic can get complicated, so it’s advisable to consult with a qualified tax professional or financial advisor to make sure the process is handled correctly and all tax consequences are understood. A Roth IRA conversion strategy may not be effective if you already have pre-tax contributions in an existing IRA, Meade added.
“Roth conversions create an immediate tax liability for the amount of funds you are converting, so multiple factors need to be considered before completing the transaction,” Foard said.
Know the Roth IRA Withdrawal Rules
To withdraw earnings tax and penalty-free, you must hold a Roth IRA for a minimum of five years and be at least 59 1/2.
“This means as long as you wait to withdraw earnings after age 59 1/2 and have had the account open for at least five years, you will owe no taxes on the money you take out. Contributions can be taken out at any time without taxes or penalties,” Meade said.
If you withdraw earnings from your Roth IRA before age 59 1/2 and have not had the account for more than five years, you may owe taxes and a 10% penalty.
“You can avoid the penalty for certain situations but not the taxes,” Meade added. “If you withdraw earnings from your Roth IRA before age 59 1/2 but you have had the account for more than five years, the same rules apply unless it is for up to $10,000 for a first-time home purchase, disability or death of the owner.”
“In those cases, after five years, you can avoid taxes and penalties,” she noted.
[READ: What Is the Roth IRA 5-Year Rule?]
Explore Where to Open a Roth IRA
As with other types of investment accounts, you can open a Roth IRA at most banks and brokerage firms. “Huge financial firms such as Charles Schwab, Fidelity, Morgan Stanley, Merrill Lynch, and many more all offer traditional and Roth IRAs,” Santiago said. “They’re heavily marketed, as Roth IRAs have become one of the most popular personal retirement savings vehicles because of the beneficial tax treatment.”
“You’ll need to provide your personal information such as name, date of birth, Social Security number, and home address, along with basic financial information such as your salary and net worth, and provide proof of identity such as a driver’s license,” Foard said.
Any U.S. resident with earned income can open a Roth IRA provided they are within the annual limits required by the IRS. For working minors under 18, a parent or legal guardian may open a custodial account on their behalf. In these cases, the account is managed by the custodian until the minor reaches 18 years of age, or 21 in some states.
Avoid Making These Mistakes When Opening a Roth IRA
Like any investment, it’s best to plan carefully before steering any cash into the account.
Avoid these mistakes when managing your Roth IRA to stay on course.
Don’t Overfund Your Account
Avoid contributing directly to a Roth IRA if you make too much money. Overfunding a Roth IRA could trigger taxes and penalties of 6% on the excess amount for every year the contribution remains in your account. These fines can be avoided by removing any excess funds ahead of your tax return due date.
Don’t Scatter Your Financial Accounts
It’s also a good idea to open your Roth IRA where you are holding your other investments or with your current advisory, Foard advised. “That will keep your financial management more efficient,” he said.
Always Double-Check the Paperwork
While most Roth IRA providers have measures in place to ensure you’ve provided all the information necessary to open the account correctly, things can go awry if you’re not careful.
“I’ve seen individuals make the mistake of not putting an actual person as their beneficiary,” Foard noted. “Unless there are specific reasons to put an entity or non-person as a beneficiary, you typically want to have a living person listed.”
Don’t Miss Contribution Deadlines
Another common mistake with Roth IRAs is simply forgetting to contribute each year.
“Once the contribution deadline passes, you cannot go back and make that contribution up for the previous year, nor can you roll those funds into the current year,” Foard added. “When you turn 50, you can increase your contribution limit by $1,000 per year to play catch-up for years where you didn’t max out the contribution or when you missed the contribution altogether.”
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How to Open a Roth IRA originally appeared on usnews.com
Update 01/25/24: This story was previously published at an earlier date and has been updated with new information.
