What You Don't Know About a Roth IRA for Retirement Savings

Updated: Jan 12



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What is a Roth IRA?


A Roth IRA is an Internal Revenue Service (IRS) approved retirement savings account in which its distributions upon retirement withdrawals are not taxable as long as the plan and withdrawals abide by the rules established by the IRS.


Key Takeaways


  • 2020 Annul Roth IRA Contribution Limits include:

  • < 50 years old: $6,000

  • > 50 years old: $7,000

  • Roth IRA is considered After-Tax Retirement Account

  • 10% penalty and taxes on earnings if early withdrawal occurs


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How Does a Roth IRA Work?


A Roth IRA invests your money that has already been taxed, also called after-tax dollars. Unlike a Traditional IRA, which invests money before it is taxed, you can invest in a Roth IRA and pay no taxes on its withdrawal distributions if you meet the guidelines in the link above.


When you open a Roth IRA, you select an investment or recommendation made by your financial advisor and then can either make a lump sum investment or make payments over time.


2020 Roth IRA Limit & Max Contribution


Since its creation, investors have seen the annual contributions limits increase. While not every year, the IRS increased the 2019 IRA Annual Contribution Limits from $5,500 to $6,000, which remained for 2020 IRA Contributions if you are under the age of 50.


For investors over the age of 50, you can make an additional $1,000 contribution in 2020 for an annual limit of $7,000. This is referred to as the Catch-Up Contribution Limit.


Both annual contribution limits will depend on your Adjusted Gross Income reported to the IRS. See below.


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Roth IRA Income & Salary Limitations


Like most tax brackets, your income determines your filing status. When it comes to IRAs, as long as your modified Adjusted Gross Income (AGI) is less than $196,000 per year when your tax status is "Married Filing Jointly" or "Qualifying Widow(er)," you can make annual contributions up to $6,000 or $7,000 per year depending on your age.



For households with income exceeding $196,000 but less than $206,000 per year, your contribution will be a reduced amount.


To learn how much you can contribute this year, review the IRS's Roth IRA Contribution Computation Chart.


Roth IRA Fees, Taxes, & Penalties


A great benefit of investing in a Roth IRA is its tax advantages. Because your Roth IRA investment is considered after-tax, your retirement account will see tax-free growth on its earnings.


It would be best if you recognized there is a difference between contributions and earnings. Because you have already been taxed on your money, Roth IRA contributions can be withdrawn with no taxes or penalties; however, your gains (profits) will be taxed to include a 10% early withdrawal penalty.


In many situations, you can choose to have the taxes pulled out immediately upon withdrawal, or you may defer it until you do your annual taxes.


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How to Open a Roth IRA


With so many investment platforms and apps at your fingertips, it is very easy to set up a Roth IRA. Unlike a traditional IRA where funds are required to be invested prior to being taxed, you can use money from garage sales, money your grandmother gave you over the Christmas break, items sold on eBay, or money from your paychecks.


There are so many options to invest with companies like Betterment, Wealthfront, Acorns (receive $10 for signing up), and very likely, your financial institution can assist.


Before you open an account, determine how much you can invest consistently. This is key because if you are under the age of 50, your annual limit is $6,000 for 2020.


With $6,000 being the max contribution this year, divide that figure by 12 months, and it equates to $500 per month. Next, depending on the frequency of your paychecks, divide $500 by the number of paychecks you receive in a month.


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For instance, if you get paid twice a month, then make a plan to invest $250 into a Roth IRA from every paycheck. Now, if you cannot reasonably make regular payments of $250, determine how much you can consistently invest from every paycheck. Even if you can only put away $50 per paycheck, it's best to start and soon so compound interest can take over.


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How to Invest in a Roth IRA


Once you have decided how much you can save towards an IRA, you must determine your risk tolerance. While you or your spouse may be risk-averse, your significant other may not be. Discuss with one another how much risk you can reasonably accept.


With the stock market continually reaching new highs, it is wise to buy low and sell high. Because of this, you want to ensure your IRA is well diversified. Consider having a mix of bonds and stocks in your portfolio. With tools from Betterment and Wealthfront, their algorithm helps you understand your risk tolerance.


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What's the Difference Between a Roth IRA and Traditional IRA


In its simplest explanation, it all depends on when the money is taxed. A Traditional IRA is taxed when you start making withdrawals during your retirement. A Roth IRA is taxed before being invested, so when you make your qualified retirement withdrawals, you are not taxed.


See our page on Individual Retirement Arrangements (IRA) to learn more about the differences between the two IRAs.


A Roth IRA can act as an additional retirement lever for you adding more income diversification. Before you start investing towards a Roth IRA, be sure to know and understand your risk tolerance, the amount you can consistently invest, and the penalties, fees, and taxes of an early withdrawal.

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