Roth IRA Explained (Retirement Savings 101)

What is a Roth IRA? Do I need a Roth IRA? What are the benefits of a Roth IRA?

Roth IRAs are an amazing way to stash money away for your future but many people don’t know enough about them.

Today I’m sharing all about Roth IRAs and why you should open a Roth IRA today if you don’t already have one.

This guide to Roth IRAs for beginners goes over a few things:

  • why you should open a Roth IRA
  • what a Roth IRA is
  • who can open a Roth IRA
  • how much you can contribute to a Roth IRA
  • benefits of using a Roth IRA
  • common Roth IRA mistakes
  • my personal experiences with Roth IRA investing
  • my recommendations on how to determine where to open a Roth IRA

If you just want to get started quickly, here are a few places I recommend for opening a Roth IRA:

Traditional brokerages with low cost funds:

Online Brokerages with great apps (affiliate links):

This video and blog post gives you a general framework for how to get started with Roth IRA investing and determining where to open an account.

Choosing Retirement Accounts

Today I’m talking all about Roth IRAs and why I think they are an awesome account type and why everyone should open one if they are eligible.

There are many different account types you can consider using when you are saving for retirement. From traditional IRAs and 401ks to Roth IRAs and 401k and 403bs and more. It can feel like. you need a whole new vocabulary just to invest.

A Roth IRA is just one type of these retirement accounts you can consider using to build up your retirement savings.

It’s one of many retirement account options so you should take your time and learn about all of them. Even if you decide you need a professional opinion and hire a financial advisor it always helps to be aware of the basics yourself.

What is a Roth IRA?

A Roth IRA is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement.

Roth IRAs are similar to traditional IRAs but taxed differently. With a Roth IRA you fund your account with money you’ve already paid taxes on, the contributions are not tax-deductible. Then when you are ready to withdraw money in the future at retirement age, the money you withdraw is tax-free.

An important thing to understand is that a Roth IRA is just a type of account. It’s not an actual investment. The Roth IRA is the account and you purchase investments to keep inside that account. Those investments then get to grow tax-free because they are inside the special Roth IRA.

It’s a favorite account of many in financial planning because of the tax-free growth and tax-free withdrawals.

Some key notes about Roth IRAs:

  • A Roth IRA is a type of retirement account where you pay taxes on money before you put it into your account and then all future withdrawals from the account are tax-free.
  • There are income limits for who can contribute. If you make too much money you can’t utilize a Roth IRA. In 2021, the limit for singles is $140,000. For married couples, the limit is $208,000.
  • Each year there is a max for how much you can contribute. This amount changes every couple of years. In 2021, the contribution limit for a Roth IRA is $6,000 a year. If you are age 50 or older you can deposit extra money to “catch up” with contributions up to $7,000.
  • You can start a Roth IRA at most brokerage firms, banks, and investment companies.
  • A Roth IRA can be established at any time. You have until that year’s tax-filing deadline, usually April 15 of the following year, to max out your contributions.
  • You can put money in your Roth IRA for as many years as you want as long as you have earned income that qualifies.
  • You can withdraw contributions from your Roth IRA, both tax- and penalty-free if you take out only an amount equal to what you’ve put in.
  • For withdrawing earnings in your Roth IRA, the current rules say that as long as you’ve owned your account for 5 years and you’re age 59½ or older, you can withdraw your money and you won’t owe any federal taxes.
  • There are not required minimum distributions like a traditional IRA that forces you to pull out money beginning at age 72.

There are also more ways to withdraw your money sooner with the ability to draw out money without penalties for things like a first-time home purchase, college expenses, and birth or adoption expenses.

You can read more about Roth IRA rules on the IRS website.

Where To Open A Roth IRA

You can start a Roth IRA at most brokerage firms, banks, credit unions and investment companies. A Roth IRA must be established somewhere that has received IRS approval to offer them.

Here are a few places I recommend for opening a Roth IRA:

Traditional brokerages with low cost funds:

Online Brokerages with great apps (affiliate links):

You have many options for where to open a Roth IRA since many institutions are able to offer this account type. Not all of these options are equal since some will be more restrictive in their offerings than others and some have higher fees that will affect your investment returns.

When you are trying to decide where to start a Roth IRA you should look for an option that fits several needs:

  • your risk tolerance
  • your investment preferences
  • your desire to be active or passive
  • the diversity of investments you can choose
  • account requirements like minimum balances

These things will determine where you want to open a Roth IRA. For example, if you plan to trade within your account you’ll want something with no fees for trades or if you want to be hands off you’ll want something that offers either low cost index funds or roboadvisors.

You’ll want to also think about the functionality of the account you open. Will you be more likely to contribute if it’s with an institution where you already have another account for example?

Most people start Roth IRAs with a brokerage since these are well known and trusted

Roth IRA Contribution Rules

The IRS has a lot of rules about Roth IRA contributions.

The contributions are capped at a certain amount each year, you can only contribute earned income, and you have to qualify via your income in order to contribute.

How much can you invest in a Roth IRA?

Each year there is a maximum amount you can contribute to a Roth IRA.

  • In 2021, the contribution limit for a Roth IRA is $6,000 a year.
  • In 2021, if you are age 50 or older you can contribute up to $7,000.

Who can contribute to a Roth IRA?

Contribution limits are set by the IRS each year and determined based on your modified adjusted gross income.

  • In 2021, the income limit for singles is $140,000 to contribute the full amount. From $125,000 to $140,000 you can contribute a reduced amount.
  • In 2021, the income limit for married couples is $208,000 to contribute the full amount. From $198,000 to $208,000 you can contribute a reduced amount.

You can view the entire chart of contribution limits on the IRS website.

What if you make too much money?

If you’re above the income limits to contribute to a Roth IRA you still have the option to utilize this account thanks to a little loophole.

You can use the backdoor Roth IRA strategy and convert an existing traditional IRA and into a Roth IRA.

When you do this you are required to pay income taxes on the contributions that were deductible along with the gains, but after that tax bill you then have a Roth IRA account with all the tax-free growth benefits.

Common Roth IRA Mistakes

There are many benefits of Roth IRAs especially the tax-free growth and withdrawals.

However, there are some drawbacks and mistakes that should be considered with this type of account.

Roth IRA Disadvantages:

  • No upfront tax break for your contributions which means you’ll get less money to budget for your life.
  • The maximum contribution is low compared to other retirement accounts like a 401k.
  • You have to set it up yourself unlike a 401k that is managed by your employer and easy to enroll.

Roth IRA Mistakes:

  • Not calculating whether you will benefit more from the Roth IRA or a traditional IRA tax wise. Whether the Roth IRA is right for you will depend on your personal income situation now vs what is expected in retirement will determine
  • Not choosing an investment when you put money into your Roth IRA. When you put money in you have to buy an actual investment like an index fund or shares of stock. Otherwise your money will be in a settlement fund not earning any interest. A Roth IRA is an account type, not an investment itself.

Despite a few disadvantages and potential mistakes most people will benefit from using an IRA. If your income, age, and tax brackets determine you would benefit from a Roth IRA then open one and get started as soon as you can!

Why I Love My Roth IRA

I started my Roth IRA while I was in college during my junior year. I had worked since I was 16 and with some extra money lying around from working throughout the school year I decided to start saving for retirement before I even graduated college.

Looking back on that decision, I think it was a pretty smart idea since that money is still in my Roth IRA today. If I had not invested back then it would have been spent frivolously.

That money I invested is still growing tax free in my Roth IRA!

I was pretty unique since starting a Roth IRA account in college is not what most college students are doing. I certainly don’t know anyone else who did it. I didn’t hear any of my friends even talk about retirement accounts until they had been several years out of college.

Many college students have never even heard of a Roth IRA because it’s not part of the common language. They might know about credit cards or student loan debt, but retirement accounts seem like something to worry about later.

There isn’t enough financial education for people at that age and that is one of the reasons why I have this blog and my YouTube channel!

We didn’t get any help in high school or college learning about personal finance. Even if classes covering personal finance exist they aren’t mandatory. This leads a lot of young people to graduate at a disadvantage where they don’t know all the options available to them like Roth IRAs.

Luckily these days more people are learning about investing and how to invest for retirement and other big financial goals.

Why You Should Open a ROTH IRA Now

If you are in college, soon to graduate, just graduated or at any time in your career (even in your 50s):

Start investing in a Roth IRA now!

This account can be your biggest ally in a secure future retirement. All of that money growing tax free will be a huge win for you in the future when you want to stop working or physically can’t work.

It might not feel fun to send money into an account you won’t use for decades, but the earlier you start investing, the better!

If you start investing earlier it’s easier to build the wealth that will help you live a great life when you are older. You can start with smaller amounts, just a few hundred a month or a couple thousand a year, and let that build momentum with the power of compound interest.

Even if you are starting later then you will still be glad you decided to invest for your future.

I’m not a professional so I can only share what I did and I would recommend doing what I did: read, research, and learn on your own.

There are lots of resources on the web with information about investing and Roth IRAs specifically. It’s unlikely that you will learn about Roth IRAs and investing so take to the web and educate yourself. You’ll be glad you did for years to come.

If you haven’t opened up a Roth IRA yet, and it makes sense for your situation then I highly recommend you do it now. Sites like M1 Finance have made it incredibly easy to start a Roth IRA for just $500.

Want to keep learning about these amazing accounts? Read Top Things to Know Before Opening a Roth IRA

Ready to max out your contributions this year? Try using a Roth IRA investing tracker!

2023 Roth IRA Challenges: Invest $6,500 or $7,500

This challenge bundle will help you track Roth IRA contributions during the year to max out this important investment account. 

There are 14 different options included in this money savings challenge to help you plan and invest money to max out your Roth IRA!

Mary is the founder of Pennies Not Perfection where she shares her journey to build wealth through online income. She quit her day job in 2021 after she paid off her debt and doubled her 9-5 salary.

Mary's favorite free financial tool is Personal Capital. She uses their free tools to track net worth and work toward to financial freedom.

Her favorite investment platform is M1 Finance, where she built a custom portfolio for free with no fees. She shares her portfolio growth and savings progress every month on YouTube.