What’s a Roth IRA?

If you've ever thought about saving for retirement, you've likely come across the suggestion of opening a Roth IRA. So, what is a Roth IRA, and how can it help you save?

An IRA is an individual retirement account. These accounts are designed to help people save and build on money earmarked for retirement. Roth IRAs allow after-tax contributions, and the account can grow tax-free for future use. Although there are no tax benefits for contributions, withdrawals from these accounts are tax and penalty-free after five years, or when the account beneficiary reaches 59.5 years old.

Contribution limits for a Roth IRA are determined by your modified adjusted gross income (MAGI). Maximum contribution limits are $6,000 per year unless you're over the age of 50, when it goes up to $7,000. For those who file taxes as single, contribution limits go down once you reach $129,000 in yearly earnings and are not allowed at all if you make $144,000 per year. Those married and filing jointly have reduced limits at $204,000 in annual earnings and are prohibited from contributing at $214,000.

Contributions can be made at any age, and there are no mandatory withdrawals after retirement, allowing continued growth. If the Roth IRA is inherited by your heirs, their withdrawals are also tax-free.

How Is It Different From a Traditional IRA?

In some cases, pre-tax dollars can be contributed to a traditional IRA, offering immediate tax benefits for contributions. Money within the account is tax-deferred, meaning income tax must be paid on future withdrawals. Contribution limits are the same for both IRA types, except maximum contributions can be made to the traditional IRA at any income level. The standard IRA also requires mandatory distributions after age 72.

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Which Is Better?

If you're eligible for either IRA type, the biggest benefit depends on future earnings. If you believe your yearly earnings will grow higher by retirement, a Roth IRA prevents you from being pushed into an even higher tax bracket. Otherwise, it's a good idea to enjoy the immediate tax benefits now and pay lower taxes when your income level drops before retirement.