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How Does a Roth IRA Work? Thumbnail

How Does a Roth IRA Work?

Retirement Planning

The Roth IRA turns traditional IRA rules upside down.  By paying tax on the money you contribute to your account, you receive tax free growth in retirement.  

Traditional Tax-deferred IRA

Contributions to a traditional tax-deferred IRA are tax deductible when your money goes into the account.  Tax on the growth, as well as the tax on your contributions, is deferred until money is withdrawn in retirement.  You get to invest free of current taxes, but in retirement you must pay tax on every dollar you withdraw.  

Roth IRA

Contributions to a Roth IRA are not tax deductible.  You must pay tax on the money you invest in a Roth IRA.  Your account grows tax-free and when you retire you can withdraw all the money free of taxes.  So, you never pay tax on the growth in a Roth IRA.  

The Pros of a Roth IRA

  • A big advantage to a Roth IRA is tax free distributions in retirement.   This is compared to fully taxable distributions from the traditional tax-deferred IRA.
  • There is no Required Minimum Distribution (RMD) for the owner of a Roth IRA.  This is compared to Required Minimum Distributions beginning at age 73 and each year thereafter for the owner of a traditional tax-deferred IRA.
  • Your heirs can inherit your ROTH IRA free of income taxes, but they must distribute the full account by the end of tenth year following the date of death of the owner.   

The Cons of a Roth IRA

  • The main disadvantage of a Roth IRA is the loss of a current income tax deduction.  For high income earners a tax deduction now may be a higher priority than tax free distributions in retirement.  If you think you will be in a lower tax bracket in retirement, it is better to take the tax deduction now with a traditional IRA.   
  • It takes time to benefit from tax free growth.  When you contribute to a Roth IRA early in your career you have plenty of time to accumulate tax free growth.  Later in your career there may not be enough time to realize this benefit.

How Do You Open a Roth IRA?

You can open a Roth IRA at your bank or in a brokerage account or mutual fund.  A financial advisor can help you get started.  You must have earned income in any year that you contribute to a Roth IRA, just the same as you would for a traditional IRA.   There is no age limit.  You cannot be too old or too young to contribute to a Roth IRA. You just have to have earned income equal to or greater than your annual contribution.  You may also move traditional IRA money into your Roth IRA.  This is called a Roth conversion.  

How Much Can You Contribute to a Roth IRA?

In 2025 the annual IRA limit is $7,000 whether you have a Roth IRA or a Traditional IRA.  You may contribute to one or both types of IRA, but you cannot exceed the annual limit when all contributions are added together.   

For taxpayers who turn 50 or older in 2025, there is a catch-up contribution allowed of an additional $1,000.  So those 50+ years old may contribute $8,000 to IRAs in 2025.  It may be all in a Roth or all in a Traditional or some combination of the two.  

IRA maximum annual limits are indexed for inflation to keep up with the cost of living, so check the limits each year.

If you are covered by an employer retirement plan your ability to contribute to a Roth IRA may be capped, based on your income.   In 2025, for single taxpayers, the amount you may contribute is gradually phased out when your modified adjusted gross income (MAGI) exceeds $150,000. If your MAGI is $165,000 or more you are not allowed to make a Roth contribution for that year .   Taxpayers married filing jointly phase out between $236,000 and $246,000 of MAGI.  

Conclusion

Younger people generally benefit more from a Roth IRA for two reasons.   They likely are earning less now than they will later in their career.   It is better to pay taxes while they are in a lower tax bracket.   Secondly, they have plenty of time to accumulate significant tax free growth and that is the big win with a Roth IRA.  

To find out more about a Roth IRA call us at 540-772-4545.

Written by Connie C. Guelich, CFP, AEP, CLU, ChFC. This represents our views at the time of this writing, and it is subject to change. It is not intended to be personal investment advice. If you would like to discuss your own account, please don’t hesitate to call us.