5 Things to Know Before You Open a Roth IRA

Saving for retirement outside of a company-sponsored retirement plan—such as a 401(k)—might be easier than you think. One excellent option is a Roth IRA. However, before you go and open a Roth IRA, there are some things that you will want to know.

What is a Roth IRA?

A Roth IRA is a retirement account that you contribute to with after-tax dollars. It then grows tax-free for the life of the account. This becomes a great option if you think you’ll be in a higher tax bracket at retirement.

Who is eligible for a Roth IRA?

Anyone is eligible for a Roth IRA that has earned income below a certain amount, depending on your filing status. However, your allowable contribution limit decreases at specific income thresholds.

If you file single, head of household, or married filing separately, then you can contribute the maximum amount to a Roth IRA if your Modified Adjusted Gross Income (MAGI) is less than $124,000 in 2020. If you are married filing jointly or qualifying widow(er) then you can contribute the maximum amount if your MAGI is less than $196,000 in 2020.

Contributions to a Roth IRA

If you are eligible to contribute to a Roth IRA, then there are limits you need to recognize. If you are under the age of 50, then your maximum annual contribution is $6,000 for 2020. If you are age 50 or older, your maximum yearly contribution is $7,000 for 2020. (These did not change from 2019.)

You are allowed to make contributions for the previous year up until the current year’s tax deadline. For example, if I am under the age of 50 and only contributed $5,000 during the 2019 calendar year, then I have until April 15, 2020, to contribute an extra $1,000 to reach the maximum annual contribution of $6,000.

You can also make contributions in any amount. Some individuals can make one large lump sum to max out their contribution, while others may make small contributions throughout the year.

Distributions from a Roth IRA

You can take distributions from your Roth IRA tax-free and penalty-free once you turn age 59 ½, and if the Roth IRA has been opened for five or more years. If you are over the age of 59 ½ and have not met the 5-year holding requirement, then the earnings will be subject to taxes, but not penalties.

However, Roth IRAs allow you to withdraw your contributions at any time and age because the money you put into the account has already been taxed. If you were to withdraw any earnings from the account before 59 ½—regardless of how long the account has been opened—then those earnings will be taxed and possibly incur a penalty. There are certain exceptions where you are allowed to make withdrawals without any taxes or penalties, but you should consult a tax specialist before taking action.

Investment Options

The first thing to note when it comes to investing is that a Roth IRA is an account that holds investments in it, rather than an investment itself. It allows for a lot of flexibility, and you have total control over what you want to invest in—whether it be stocks, mutual funds, bonds, etc. This is unlike some company-sponsored accounts, such as a 401(k), where you have to choose from a select list of investments. However, once you contribute to your Roth IRA, you have to take action to invest the cash. It will not automatically be invested.

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