Thinking About Opening a Roth IRA? Here Are the Main Benefits and Drawbacks

Thinking About Opening a Roth IRA? Here Are the Main Benefits and Drawbacks

July 5, 2020
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Planning for retirement is an important part of a long-term financial strategy. A Roth IRA can provide a good source of income during retirement, but it does have other benefits and drawbacks to consider.

Planning for retirement is an important part of a long-term financial strategy. A Roth IRA can provide a good source of income during retirement, but it does have other benefits and drawbacks to consider.

What is a Roth IRA?

A Roth IRA is a type of individual retirement account. The defining features of the Roth IRA revolve around taxes: you contribute money that you’ve already paid taxes on, and do not have to pay any taxes on the growth of your investments. By comparison, a traditional IRA accepts contributions that are not taxed, but you must pay tax when you withdraw earnings.

You are able to open a Roth IRA at any age to get started, as long as you have earned income, but in order to contribute money to the account, your income must fall within a specific range, described below.

Benefits of a Roth IRA

One of the benefits for a Roth IRA is that it has the ability to generate tax-free income. This means that you’re paying taxes up front before making a contribution into the Roth IRA. Since the money is taxed before going into the account, when the age 59 ½ is reached and into retirement, the money, both contributions and earnings, is able to be withdrawn from the account tax-free.

You are able to withdraw the money from the account any time, however, to withdraw before the age of 59 ½, there are a few things to know. You will have to pay income tax and a 10% penalty if you do decide to withdraw early.

There are a few instances where you are able to withdraw the money penalty free. If you are planning to use the funds for a first-time home purchase or to pay for college, then there is no penalty, even though there could be a limit to how much you can withdraw.

Drawbacks of a Roth IRA

Although you get a tax-break when you reach retirement age, one of the drawbacks is that you still have to pay taxes up front.

The amount you can contribute to the account each year is capped at $6,000. That means if you are under 50 you aren’t able to contribute more, since the contributions can’t be more than you earn as well. Once you reach the age of 50, that limit goes up to $7,000 per year. The timing is flexible whether you want to contribute all at once or split up your contributions over the course of the year.

To contribute to a Roth IRA, there are income requirements that need to be met. As of the year 2019, you need to make less than $122,000 annually as a single tax filer and less than $193,000 if you are married filing jointly to be able to contribute the full amount.

While you have to set up the Roth IRA account on your own, you do get a say in what you invest in. However, that means that more research needs to be done about what to invest in and what investing strategy is an overall best solution for you. If you do choose to open a Roth IRA, picking a provider, usually online brokers or banks, is the first step towards opening up an account.

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