You'll dream about Roth IRAs after this.
Oh, retirement. I feel like we all know we should invest for the future. But it's. All. So. Confusing. I mean, just look at one popular retirement account: the Roth IRA. What even is that??
Nora Carol Photography / Getty Images, Miles Brown / Via Giphy / giphy.com
There's a ton of stuff to learn when it comes to retirement and finances. Even just the vocab alone makes me feel like I'm learning a second language.
Before we get into the nitty gritty, you should know that a Roth IRA is a type of investment account, so there is a chance that it could lose money.
So, with that in mind, here are 14 things you should know about Roth IRAs:
To learn more about Roth IRAs specifically, I interviewed financial expert Nancy DeRusso, who is the managing director and head of financial wellness at Goldman Sachs Ayco Personal Financial Management. Nancy broke it all down and made it easier to understand than I thought, thank goodness.
1. To start, a Roth IRA is a kind of investing account that's designed to help you save for retirement.
Atu Images / Getty Images
Nancy DeRusso describes a Roth IRA in a simple and straightforward way: "investing with after-tax dollars."
Basically, a Roth IRA is a retirement account where you can deposit post-tax money to grow your future nest egg. Post-tax means income that you've already paid taxes on.
Once money is in your Roth IRA, then you can ~allocate~ or divide it among different stocks, funds, and other investment assets. And when you wanna take money out of your Roth IRA, you can take this out tax-free as long as certain conditions are met (we'll get to those in a minute).
BTW, here are some vocab words that are important to know:
• Contribution: money you put into the Roth IRA
• Distribution: money you take out of the Roth IRA
2. And it's helpful to know the difference between a Roth IRA, traditional IRA, and 401(k).
Nora Carol Photography / Getty Images
All these different retirement accounts can be confusing, so here's your cheatsheet to all the differences:
Roth (Roth IRA or Roth 401(k)):
• You're contributing money that's already taxed
• When you withdraw the money to use it, you don't pay taxes
Traditional (traditional IRA and traditional 401(k)):
• You're putting money in that hasn't been taxed yet
• When you withdraw the money to use it in retirement, that's when you pay taxes
IRA vs. 401(k):
• 401(k)s requires an employer to sponsor this retirement account
• IRAs don't require an employer, so anyone can open one
3. Unlike traditional IRAs and 401(k)s which you can write off, contributing to a Roth IRA doesn't impact your taxes now.
If you've ever done your taxes before, there's an option for you to either write off itemized deductions or take a standard deduction. Unlike a traditional IRA or 401(k), if you choose to itemize your deductions, you can't write off your Roth IRA contributions as a deduction.
Actually, you don't even need to report the money you put into a Roth IRA on your tax return since it's income that you're paying taxes on now.
4. With a Roth IRA, you can take money out before retirement without paying penalties once you've had the account open for 5 years.
Nickelodeon / Via giphy.com
Generally, you can't withdraw money out of a traditional IRA or 401(k) until you turn 59 1/2 years old, or you'll get hit with a 10% early withdrawal penalty. But Nancy says one of the main benefits of a Roth over a traditional IRA is the "ability to take your contributions without tax or penalty at any time."
You can also take out earnings without the penalty for certain specific items — for instance, you can take out up to $10,000 for first-time homebuyers!
Another big difference: "With a traditional IRA, you're required to take some sort of minimum distribution once you hit age 72. But with a Roth, you don't have to." This means that with a Roth IRA, you get to decide when you want to take money out.
Nancy recommends, "When you take those distributions, make sure you actually talk to a human to make sure that you're doing the right thing at the time." This stuff can be tricky (and mistakes can be costly), so it helps to have an expert talk you through it.
5. And, unlike a 401(k), a Roth IRA isn't tied to an employer. Anyone who earns income can open a Roth IRA.
NBC / Reveille Productions / Via giphy.com
You might think that you need an employer-sponsored 401(k) to start saving for retirement, but Nancy says that's just not the case. "The Roth IRA you do outside on your own, so it doesn't matter what company you're with or where you are."
Since a Roth IRA doesn't need to be tied to an employer, it's a great option if:
• You're self-employed
• Your employer doesn't offer retirement benefits
• You have a 401(k) and want to open an additional investment account to supercharge your retirement savings
6. If you've left an employer, you can roll over your old 401(k) into an IRA that you control — but there are a couple rules to keep in mind.
Nora Carol Photography / Getty Images
If you have a 401(k) that you wanna roll over to an IRA, it's a relatively simple process that involves filling out some forms. But keep in mind there are some rules for rollovers:
• You can roll over a traditional 401(k) to traditional IRA or Roth 401(k) to Roth IRA easily and without paying taxes
• If you want to roll over a traditional 401(k) to a Roth IRA, you will have to pay income tax on the rollover amount that year
• You are not allowed to roll over a Roth 401(k) to a Traditional IRA
7. And if you wanna open a Roth IRA, there are two big ~rules~ you need to know about first.
Dimension Films / Via giphy.com
Roth IRAs have two big restrictions:
• Income limits determine if you are even allowed to open a Roth and how much you can put in.
• Yearly contribution limits tell you how much you can put in every year.
8. First, you can’t contribute to a Roth IRA if you make more than $208,000 (married) or $140,000 (single).
Charis Barg
The IRS has rules on how much you can contribute based on your income. In simple terms, you can't contribute at all if you make more than $208,000 (married) or $140,000 (single).
Not to make it too confusing, but this limit is based on your income before certain deductions — the IRS calls this modified adjusted gross income (MAGI).
If you're interested in the very specific details, you can read about how to figure out this exact number for yourself here.
9. Second, there’s a max amount you can put in every year — currently $6,000 if you're under 50.
Erhui1979 / Getty Images
You can put up to $6,000/year into IRA accounts (up to $7,000 if you're over 50 years old).
To be clear: If you want multiple IRA accounts (Roth or traditional), the max is $6,000/year total, not $6,000/year into each account.
On the other hand, there’s no IRS minimum that you have to contribute. But there may be minimums depending on the company that you're opening the Roth IRA with.
10. If you break these rules, you'll be hit with a ~penalty~, even if you did it accidentally (sorry).
Government: You owe us money. It’s called taxes.Me: How much do I owe?Gov’t: You have to figure that out.Me: I just pay what I want?Gov’t: Oh, no we know exactly how much you owe. But you have to guess that number too.Me: What if I get it wrong?Gov’t: You go to prison
11. If your income is too high to contribute to a Roth IRA, there’s a workaround called the Backdoor Roth.
Fox / Via giphy.com
It’s called the Backdoor Roth, but it’s not shady or illegal.
According to Nancy, instead of contributing to a Roth IRA directly, "you can make a non-deductible contribution to a traditional IRA and then convert that into a backdoor Roth."
Some things to note with this:
• This isn't tax evasion, so the year that you convert the money from the traditional to Roth, you will pay income tax on it.
• "For each IRA conversion you make, you have to wait a separate five years" to be able to withdraw money.
The process can be complicated, so it's generally a good idea to talk to a financial advisor if this is something you're considering.
12. If a Roth IRA sounds like it could work for you, you might want to open one sooner rather than later.
Wenmei Zhou / Getty Images
Per Nancy, because of the "issue about waiting the five years, doing something early, even if it's small, gives you that flexibility." Basically, the sooner you start investing in a Roth IRA, the longer you'll have to grow your retirement fund ~and~ the sooner you'll be able to take withdrawals from it if you need to.
13. Wanna open a Roth IRA? You have options!
CBC / Via giphy.com
Financial institutions like banks or brokerages offer Roth IRAs. It's up to you to decide who to go with. You can try:
• Asking if your bank offers it
• Doing research to find a broker that works for you
• Ask a financial advisor for help on how and where to start one
• Using an investing app like Acorns
But Nancy notes that "people love to just read and get informed, and you can get in circles with the nuance. Before you actually make the decision, have a conversation [with a financial advisor]." Seeking out advice from a financial pro or a pal with more money knowledge can be really helpful if you're still not sure where to start.
14. But, of course, think about your finances as a whole and save or invest for your retirement in a way that works for you.
Demic / Via Giphy / giphy.com
Regardless of whether you decide to open a Roth IRA or not, Nancy left me with some great advice:
"Understand your entire situation to help you make a more informed holistic decision."
At the end of the day, your situation is unique and you know your own needs best. Always do your research, seek out expert opinions when you get stuck, and do what's best for you.
