Roth IRA 101

The Roth IRA was born on January 1, 1998 as a result of the Taxpayer Relief Act of 1997. Subsequent legislation allowed employers to offer Roth accounts in 401k and 403b plans. The accounts are named after the late Senator William V. Roth, Jr.

Roth accounts provide no deduction for contributions, but instead provide a benefit that isn’t available for traditional retirement accounts: if you meet certain requirements, all earnings are tax free when you or your beneficiary withdraw them. Other benefits include avoiding the early distribution penalty on certain withdrawals, and eliminating the need to take minimum distributions after age 72.

Plus and minus

The chief advantage of the Roth IRA is obvious: the ability to have investment earnings completely escape taxation. The advantage comes at a price, though: you don’t get a deduction when you contribute to the Roth IRA.

So which is more important? It depends on your personal situation, and also on what assumptions you want to make about the future. How long before you withdraw money from your IRA? What will your tax bracket be then? What investment earnings can you anticipate in the interim?

You can do lots of fancy analysis, but the bottom line is that most people are better off in a Roth. The chief reason is that a Roth IRA is effectively bigger than a traditional IRA because it holds after-tax dollars. If you can take advantage of this feature of the Roth IRA by maximizing your contributions you’ll add greater tax leverage to your retirement savings.

There are two other significant advantages to the Roth IRA. One is that the minimum distribution rules don’t apply. If you’re able to live on other resources after retirement, you don’t have to draw on your Roth IRA at age 72. That means your earnings continue to grow tax-free. The other big advantage is the ability to take certain early distributions without paying the early distribution penalty. In short, the Roth IRA makes it easier to keep your money in, and also easier to take your money out.

Eligibility

You can establish a Roth IRA by making a regular contribution to a Roth IRA or by converting a traditional IRA to a Roth IRA.

You may be eligible to make a regular contribution to a Roth IRA even if you participate in a retirement plan maintained by your employer. For 2017 or 2018, these contributions can be as much as $6,000 ($7,000 if you’re 50 or older by the end of the year). There are just two requirements. First, you or your spouse must have qualifying income at least equal to the amount contributed. And second, your modified adjusted gross income can’t exceed certain limits. For the maximum contribution in 2021, the limits are $125,000 for single individuals and $198,000 for married couples filing joint returns. As your income grows above these levels, the amount you can contribute is reduced gradually and then completely eliminated. Dollar amounts for years other than 2021 can be found in our Reference Room.

Another way to get money into a Roth IRA is convert a traditional retirement account to a Roth. An income limitation that applied before 2010 has been repealed, so all taxpayers are eligible to do this. You’ll have to pay tax in the year of the conversion, but for many people the long-term savings outweigh the conversion tax.

Distributions

Distributions from Roth IRAs are tax-free until you’ve withdrawn all your regular contributions. After that you’ll withdraw your conversion contributions, if any. When you’ve withdrawn all your contributions (regular and conversion), any subsequent withdrawals come from earnings. Withdrawals of earnings are tax-free if you’re over age 59½ and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions) they’re taxable and potentially subject to the early withdrawal penalty.

There’s more

This brief summary omits many details. For more information return to the top page of this Guide to Roth Accounts for a list of topics.