A Roth IRA (Individual Retirement Account) is a type of retirement savings account in the United States that offers certain tax advantages to encourage individuals to save for retirement. It was established by the Taxpayer Relief Act of 1997 and is named after its chief legislative sponsor, Senator William Roth.
Contributions to a Roth IRA are made with after-tax dollars, meaning that you’ve already paid income taxes on the money you’re putting into the account. While there is no tax deduction for contributions made to a Roth IRA, the significant benefit comes from the fact that all earnings and withdrawals from the account, once you reach 59.5 years old and if the account has been held for at least five years, are generally tax-free.
This is different from a traditional IRA, where contributions may be tax-deductible (depending on your income and whether you or your spouse are covered by a retirement plan at work), but withdrawals in retirement are taxed as ordinary income.
Other notable features of a Roth IRA include:
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, which mandate that you begin taking distributions at a certain age (currently 72), Roth IRAs have no such requirement during the lifetime of the original owner. This allows for more flexibility in retirement planning and for wealth to be passed on to heirs.
- Income limits: Not everyone can contribute to a Roth IRA. The ability to contribute is phased out at higher income levels. The exact figures vary year by year and depend on your tax filing status.
- Contribution limits: The maximum annual contribution is subject to change, but as of 2021, the limit is $6,000 per year or $7,000 for individuals aged 50 and over.
It’s also worth noting that Roth IRA contributions can be withdrawn at any time without penalty or taxes because they were made with after-tax money. However, this isn’t the case for the earnings on those contributions—they are subject to taxes and penalties if withdrawn before age 59.5 and before you’ve held the account for five years.