What Is a Roth IRA and How Does It Work?

By AJ Smith · May 23, 2024 · 14 minute read

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What Is a Roth IRA and How Does It Work?

A Roth IRA is an individual retirement account that allows you to contribute after-tax dollars, and then withdraw the money tax free in retirement. A Roth IRA is different from a traditional IRA, which is a tax-deferred account: meaning, you contribute pre-tax dollars — but you owe tax on the money you withdraw later.

Many people wonder what a Roth IRA is because, although it’s similar to a traditional IRA, the two accounts have many features and restrictions that are distinct from each other. Roth accounts can be more complicated, but for many investors the promise of having tax-free income in retirement is a strong incentive for understanding how Roth IRAs work.

Key Points

•   A Roth IRA is a retirement savings account that offers tax-free growth and tax-free withdrawals in retirement.

•   Contributions to a Roth IRA are made with after-tax dollars, but qualified withdrawals are not subject to income tax.

•   Roth IRAs have income limits for eligibility, and contribution limits that vary based on age and income.

•   Unlike traditional IRAs, Roth IRAs do not require minimum distributions during the account holder’s lifetime.

•   Roth IRAs can be a valuable tool for long-term retirement savings, especially for individuals who expect to be in a higher tax bracket in the future.

What Is a Roth IRA?

A Roth IRA is a retirement account for people who want to make after-tax contributions. The trade-off for paying taxes upfront is that when you retire, all of your withdrawals will be tax free, including the earnings and other gains in your account.

That said, because you’re making after-tax contributions, you can’t deduct Roth deposits from your income tax the way you can with a traditional IRA.

Understanding Contributions vs Earnings

An interesting wrinkle with a Roth IRA is that you can withdraw your contributions tax and penalty-free at any time. That’s because you’ve already paid tax on that money before initially depositing or investing it.

Withdrawing investment earnings on your money, however, is a different story. Those gains need to stay in the Roth for a minimum of five years before you can withdraw them tax free — or you could owe tax on the earnings as well as a 10% penalty.

It’s important to know how the IRS treats Roth funds so you can strategize about the timing around contributions, Roth conversions, as well as withdrawals.

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Roth IRA Eligibility

Technically, anyone can open an IRA account, as long as they have earned income (i.e. taxable income). The IRS has specific criteria about what qualifies as earned income. Income from a rental property isn’t considered earned income, nor is child support, so be sure to check.

There are no age restrictions for contributing to a Roth IRA. There are age restrictions when contributing to a traditional IRA, however.

How to Open a Roth IRA

Roth IRA Annual Contribution Limits

For 2024, the annual limit is $7,000, and $8,000 for those 50 and up. The extra $1,000 is called a catch-up provision, for those closer to retirement.

For 2023, the annual contribution limits for both Roth and traditional IRAs was $6,500, or $7,500 for those 50 or older. So, there was a $500 increase in contribution limits between 2023 and 2024.

Remember that you can only contribute earned income. If you earn less than the contribution limit, you can only deposit up to the amount of money you made that year.

One exception is in the case of a spousal Roth IRA, where the working spouse can contribute to an IRA on behalf of a spouse who doesn’t have earned income.

Other Roth IRA Details

Since Roth IRAs are funded with after-tax income, contributions are not tax-deductible. One exception for low- and moderate-income individuals is something called the Saver’s Credit, which may give someone a partial tax credit for Roth contributions, assuming they meet certain income and other criteria.

Note that the deadline for IRA contributions is Tax Day of the following year. So for tax year 2023, the deadline for IRA contributions is April 15, 2024. But, if you file an extension, you cannot further postpone your IRA contribution until the extension date and have it apply to the prior year.

Roth IRA Income Restrictions

In addition, with a Roth there are important income restrictions to take into account. Higher-income individuals may not be able to contribute the full amount to a Roth IRA; some may not be eligible to contribute at all.

It’s important to know the rules and to make sure you don’t make an ineligible Roth contribution if your income is too high. Those funds would be subject to a 6% IRS penalty.

For 2023:

•   You could contribute the full amount to a Roth as long as your modified adjusted gross income (MAGI) was less than $138,000 (for single filers) or less than $218,000 for those married, filing jointly.

•   Single people who earned more than $138,000 but less than $153,000 could contribute a reduced amount.

•   Married couples who earned between $218,000 and $228,000 could also contribute a reduced amount.

For 2024 the numbers have changed and the Roth IRA income limits have increased:

•   For single and joint filers: in order to contribute the full amount to a Roth you must earn less than $146,000 or $230,000, respectively.

•   Single filers earning more than $146,000 but less than $161,000 can contribute a reduced amount. (If your MAGI is over $161,000 you can’t contribute to a Roth.)

•   Married couples who earn between $230,000 and $240,000 can contribute a reduced amount. (But if your MAGI is over $240,000 you’re not eligible.)

If your filing status is…

If your 2023 MAGI is…

If your 2024 MAGI is…

You may contribute:

Married filing jointly or qualifying widow(er) Up to $218,000 Up to $230,000 For 2023 $6,500 or $7,500 for those 50 and up.
For 2024 $7,000 or $8,000 for those 50 and up.
$218,000 to $228,000 $230,000 to $240,000 A reduced amount*
Over $228,000 Over $240,000 Cannot contribute
Single, head of household, or married filing separately (and you didn’t live with your spouse in the past year) Up to $138,000 Up to $146,000 For 2023 $6,500 or $7,500 for those 50 and up.
For 2024 $7,000 or $8,000 for those 50 and up.
From $138,000 to $153,000 From $146,000 to $161,000 Reduced amount
Over $153,000 Over $161,000 Cannot contribute
Married filing separately** Less than $10,000 Less than $10,000 Reduced amount
Over $10,000 Over $10,000 Cannot contribute

*Consult IRS rules regarding reduced amounts.
**You did live with your spouse at some point during the year.

Advantages of a Roth IRA

Depending on an individual’s income and circumstances, a Roth IRA has a number of advantages.

Advantages of a Roth IRA

•   No age restriction on contributions. With a traditional IRA, individuals must stop making contributions at age 72. A Roth IRA works differently: Account holders can make contributions at any age as long as they have earned income for the year.

   * You can fund a Roth and a 401(k). Funding a 401(k) and a traditional IRA can be tricky, because they’re both tax-deferred accounts. But a Roth is after-tax, so you can contribute to a Roth and a 401(k) at the same time (and stick to the contribution limits for each account).

•   Early withdrawal option. With a Roth IRA, an individual can generally withdraw money they’ve contributed at any time, without penalty (but not earnings on those deposits). In contrast, withdrawals from a traditional IRA before age 59 ½ may be subject to a 10% penalty.

•   Qualified Roth withdrawals are tax-free. Investors who have had the Roth for at least five years, and are at least 59 ½, are eligible to take tax- and penalty-free withdrawals of contributions + earnings.

•   No required minimum distributions (RMDs). Unlike IRAs, which require account holders to start withdrawing money after age 73, Roth IRAs do not have RMDs. That means an individual can withdraw the money as needed, without fear of triggering a penalty.

Disadvantages of a Roth IRA

Despite the appeal of being able to take tax-free withdrawals in retirement, or when you qualify, Roth IRAs have some disadvantages.

•   No tax deduction for contributions. The primary disadvantage of a Roth IRA is that your contributions are not tax deductible, as they are with a traditional IRA and other tax-deferred accounts (e.g. a SEP IRA, 401(k), 403(b)).

•   Higher earners often can’t contribute to a Roth. Affluent investors are generally excluded from Roth IRA accounts, unless they do what’s known as a backdoor Roth or a Roth conversion. (There are no income limits for converting a traditional IRA to a Roth, but you’ll have to pay taxes on the money that goes into the Roth — though you won’t face a penalty.)

•   The 5-year rule applies. The 5-year rule can make withdrawals more complicated for investors who open a Roth later in life. If you open a Roth or do a Roth conversion at age 60, for example, you must wait five years to take qualified withdrawals of contributions and earnings, or face a penalty (some exceptions to this rule apply; see below).

Last, the downside with both a traditional or a Roth IRA is that the contribution limit is low. Other retirement accounts, including a SEP-IRA or 401(k), allow you to contribute far more in retirement savings. But, as noted above, you can combine saving in a 401(k) with saving in a Roth IRA as well.

Roth IRA Withdrawal Rules

Because Roth IRA withdrawal rules can be complicated, let’s review some of the ins and outs.

Qualified Distributions

Since you have already paid tax on the money you deposit, you’re able to withdraw contributions at any time, without paying taxes or a 10% early withdrawal penalty.

For example, if you’ve contributed $25,000 to a Roth over the last five years, and your investments have seen a 10% gain (or $2,500), you would have $27,500 in the account. But you could only withdraw up to $25,000 of your actual deposits.

Withdrawing any of the $2,500 in earnings would depend on your age and the 5-year rule.

The 5-Year Rule

What is the 5-year rule? You can withdraw Roth account earnings without owing tax or a penalty, as long as it has been at least five years since you first funded the account, and you are at least 59 ½. So if you start funding a Roth when you’re 60, you still have to wait five years to take qualified withdrawals.

The 5-year rule applies to everyone, no matter how old they are when they want to withdraw earnings from a Roth.

There are some exceptions that might enable you to avoid owing tax or a penalty.

Non-Qualified Withdrawals

Non-qualified withdrawals of earnings from a Roth IRA depends on your age and how long you’ve been funding the account.

•   If you meet the 5-year rule, but you’re under 59 ½, you’ll owe taxes and a 10% penalty on any earnings you withdraw, except in certain cases.

•   If you don’t meet the 5-year criteria, meaning you haven’t had the account for five years, and if you’re less than 59 ½ years old, in most cases you will also owe taxes and a 10% penalty.

There are some exceptions that might help you avoid paying a penalty, but you’d still owe tax on the early withdrawal of earnings.


Again, these restrictions apply to the earnings on your Roth contributions. (You can withdraw direct contributions themselves at any time, for any reason, tax and penalty free.)

You can take an early or non-qualified withdrawal prior to 59 ½ without paying a penalty or taxes, as long you’ve been actively making contributions for at least five years, in certain circumstances, including:

•   For a first home. You can take out up to $10,000 to pay for buying, building, or rebuilding your first home.

•   Disability. You can withdraw money if you qualify as disabled.

•   Death. Your heirs or estate can withdraw money if you die.

Additionally you can avoid the penalty, although you still have to pay income tax on the earnings, if you withdraw earnings for:

•   Medical expenses. Specifically, those that exceed 7.5% of your adjusted gross income.

•   Medical insurance premiums. During a time in which you’re unemployed.

•   Qualified higher education expenses.

Not only are the early withdrawal restrictions looser than with a traditional IRA, the post-retirement withdrawal restrictions are lesser, as well. Whereas account holders are required to start taking distribution of funds from their IRA after age 73, there is no pressure to take distribution from a Roth IRA at any age.

Roth IRA vs Traditional IRA

There are certain things a Roth IRA and a traditional IRA have in common, and several ways that they differ:

•   It’s an effective retirement savings plan: Though the plans differ in the tax benefits they offer, both are a smart way to save money for retirement.

•   Not an employer-sponsored plan: Individuals can open either type of IRA through a financial institution, and select their own investments or choose an automated portfolio.

•   Maximum yearly contribution: For 2023, the annual limit is $6,500, with an additional $1,000 allowed in catch-up contributions for individuals over age 50. For 2024 it’s $7,000, and $8,000 if you’re 50 and older.

There are also a number of differences between a Roth and a traditional IRA:

•   Roth IRA has income limits, but a traditional IRA does not.

•   Roth IRA contributions are not tax deductible, but contributions you make to a traditional, tax-deferred IRA are tax deductible.

•   Roth IRA has no RMDs. Individuals can withdraw money when they want, without the age limit imposed by a traditional IRA.

•   Roth IRA allows for penalty-free withdrawals before age 59 ½. While there are some restrictions, an account holder can typically withdraw contributions (if not earnings) before retirement.

Is a Roth IRA Right for You?

How do you know whether you should contribute to a Roth IRA or a traditional IRA? The quiz below or this checklist might help you decide.

•   You might want to open a Roth IRA if you don’t have access to an employer-sponsored 401(k) plan, or if you do have a 401(k) plan but you’ve already maxed out your contribution there. You can fund a Roth IRA and an employer-sponsored plan.

•   Because contributions are taxed immediately, rather than in retirement, using a Roth IRA can make sense if you are in a lower tax bracket or if you typically get a refund from the IRS. It may also make sense to open a Roth IRA if you expect your tax bracket to be higher in retirement than it is today.

•   Individuals who are in the beginning of their careers and earning less might consider contributing to a Roth IRA now, since they might not qualify under the income limits later in life.

•   A Roth IRA can be helpful if you think you’ll work past the traditional retirement age.

The Takeaway

A Roth IRA has many of the same benefits of a traditional IRA, with some unique aspects that can be attractive to some people saving for retirement. With a Roth IRA you don’t have to contend with required minimum distributions (RMDs); you can contribute to a Roth IRA at any age; and qualified withdrawals are tax free. With all that, a Roth IRA has a lot going for it.

That said, not everyone is eligible to fund a Roth IRA. You need to have earned income, and your annual household income cannot exceed certain limits. Also, even though you can withdraw your Roth IRA contributions at any time without owing a penalty, the same isn’t true of earnings.

You must have been funding your Roth for at least 5 years, and you must be at least 59 ½, in order to make qualified withdrawals of earnings. Otherwise, you would likely owe taxes on any earnings you withdraw — and possibly a penalty. Still, the primary advantage of a Roth IRA — being able to have an income stream in retirement that’s completely tax free — can outweigh some of the restrictions for certain investors.

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Are Roth IRAs insured?

If your Roth IRA is held at an FDIC-insured bank and is invested in bank products like certificates of deposit (CDs) or money market account, those deposits are insured up to $250,000 per depositor, per institution. On the other hand, if your Roth IRA is with a brokerage that’s a member of the Securities Investor Protection Corporation (SIPC), and the brokerage fails, the SIPC provides protection up to $500,000, which includes a $250,000 limit for cash. It’s important to note that neither FDIC or SIPC insurance protects against market losses; they only cover losses due to institutional failures or insolvency.

How much can I put in my Roth IRA monthly?

For tax year 2023, the maximum you can deposit in a Roth or traditional IRA is $6,500, or $7,500 if you’re over 50. How you divide that per month is up to you. You just can’t contribute more than the annual limit.

Who can open a Roth IRA?

Anyone with earned income (i.e. taxable income) can open a Roth IRA, but your income must be within certain limits in order to fund a Roth.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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