What Are Roth IRAs and How Do They Work?


what is a roth ira


This article originally appeared in the financial education center on Prudential.com. For more than 140 years, Prudential Financial has helped individual and institutional customers grow and protect their wealth. Prudential is known for delivering on its promises to its customers, and is recognized as a trusted brand and one of the world’s most admired companies* .

Key Takeaways

  • A Roth IRA is a type of tax-advantaged retirement savings account.
  • While you pay income taxes on your contributions to a Roth, the money grows tax-free and withdrawals during retirement aren’t taxed.
  • Roth IRAs give retirees flexibility with account withdrawal and tax planning.

What Is a Roth IRA Account?

A Roth IRA is an account that allows you to save for retirement while minimizing your future taxes. While you’ll have to pay income taxes now on money that you put into a Roth IRA, the money that you deposit will grow tax-free. After age 59 1/2, any money you withdraw won’t be taxed—as long as you’ve had the account for at least five tax years.

The ability to make tax-free withdrawals is what differentiates Roth IRAs from traditional IRAs; with traditional IRAs, you can only make tax-free deposits. As a result, Roth IRAs are often a great resource for young savers or anyone who thinks their tax bracket will be higher in retirement.

Even if you’re not sure whether your tax bracket will increase, you still might want to consider a Roth IRA if you qualify to open one based on your income. Unlike most retirement accounts, Roth IRAs don’t require minimum withdrawals during retirement. This can be helpful if you’re hoping to minimize taxes in retirement.

Roth IRAs offer flexibility before retirement, too. You can withdraw your contributions from your account at any time without paying income tax or a penalty. However, if you’re under the age of 59 1/2, you’ll have to pay taxes on the account’s growth—and unless you use the money for qualified expenses Open in a new window, such as medical bills or college tuition, a tax penalty as well.

How Do Roth IRAs Work?

Now that you know the answer to the question “What is a Roth IRA account?” you might be wondering exactly how this type of account works. As long as you meet the income limits, you can contribute to a Roth IRA. And you can continue contributing to your employer’s 401(k) account too, if you have one. You can open a Roth IRA via most brokerages, either online or in-person.

Roth IRA Contributions and Limits

In 2020, people under 50 years old can contribute up to $6,000 to a Roth IRA account. If you’re 50 or older, you can contribute up to $7,000. A 25-year-old who opens a Roth IRA and maxes out their contributions this year and every year going forward would have more than $1 million in their account by the time they’re 66 years old.

If you’re single and you make $124,000 or more, the amount you can contribute is reduced; if you make more than $139,000, you’re ineligible for a Roth IRA account. For married couples, the reduced contribution takes effect if their combined income ranges from $196,000 to $206,000.

Once you’ve made an initial deposit, you’ll need to choose which investments to purchase. If you’re saving for retirement, it’s wise to buy a well-diversified mix of stocks and bonds that reflects your time until retirement and risk tolerance. If you’re not sure where to invest your money, an investment advisor can help you. You can also invest your money in a target-date fund, which automatically adjusts its stock and bond holdings over time.

You can make contributions to your Roth IRA all at once or through multiple deposits over the course of the year. If you opt for the latter route, set up automatic contributions to ensure you’re putting money into the account on a regular basis. Keep in mind that contributions made through next year’s tax deadline count toward the current year’s contribution.

What You Can Do Next?

If you think a tax-free retirement account is right for you, contact a financial professional to help you open a Roth IRA account. Consider your goals when making investment choices and set up direct deposit to make it easier to save.

Please consult your tax and legal advisors regarding your particular circumstances.

* As of January 2020. FORTUNE® and “The World’s Most Admired Companies® are registered trademarks of Time, Inc.

©2020 Prudential Financial, Inc. and its related entities. Used by permission. Prudential is not maintaining or updating this content and disclaims any liability to any party for the accuracy or completeness of the content.

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