Roth IRA Basics: What It Is, How It Works

What is a Roth IRA?

A Roth IRA is a type of individual retirement account that lets you contribute after-tax money to save for retirement. The main draw of a Roth IRA is that the money grows tax-free and can be withdrawn tax-free after age 59 ½ as long as the account has been open for at least five years.

The main difference between a Roth IRA and a traditional IRA is tax treatment. In a traditional IRA, contributions are tax-deductible in the year they're made, but withdrawals in retirement are taxed as ordinary income.

How does a Roth IRA work?

You contribute to a Roth IRA using money that has already been taxed. Those contributions can then be invested in stocks, ETFs, bonds or more. Over time, the investments in your Roth IRA could earn a return, growing tax-free. In retirement, you'll also get to withdraw those earnings tax-free as long as you follow withdrawal rules.

How do I contribute to a Roth IRA?

You can contribute to a Roth IRA using money earned from a job, but contributions could also come from a Roth 401(k) plan rollover, a conversion from an existing traditional IRA or 401(k) plan, a spousal contribution or other transfer.

It’s important to note there are limits on how much you can contribute to a Roth IRA. In 2024, for example, that limit is $7,000 if you’re under 50 years old. You can contribute to an IRA all the way up until the tax filing deadline, which gives you until April 15, 2025, to make contributions that count toward the 2024 calendar year.

» See how your contributions can grow with our free Roth IRA calculator.

Types of investments in a Roth IRA

After opening a Roth IRA and making your contributions, you can choose where to invest that money. Without choosing investments, the funds in your Roth IRA won’t have the chance to grow.

The most common allowable investments in a Roth IRA include:

1. Stocks: Individual company shares.

2. Bonds: Government, municipal and corporate bonds.

3. Mutual funds: Actively or passively managed funds pooling various investments.

4. Exchange-traded funds (ETFs): Diversified, low-cost funds traded like stocks.

5. Index funds: Funds tracking specific market indexes.

6. Certificates of deposit (CDs): Fixed-income investments from banks.

» Read more about the best Roth IRA investments.

Setting up a Roth IRA

A Roth IRA can be opened through any financial institution, such as a bank, brokerage or robo-advisor, that has been approved by the IRS to offer IRAs. It’s easy to get started, and as part of the account setup process, you’ll need to provide a few pieces of information. This could include your ID, such as a passport or driver’s license, bank account information and proof of employment.

Choosing where to open your Roth IRA depends on your preferences. Consider whether you want to manage the account yourself or be hands-off, as well as what types of investments you want access to. If you’d like to manage your own Roth IRA, you can consider opening one at a brokerage; otherwise, a robo-advisor could be a good choice for passive management.

» Step-by-step: How to open a Roth IRA.

» Explore the best Roth IRA accounts.

Roth IRA eligibility rules

When it comes to Roth IRAs, the maximum contribution amount for 2024 and 2025 is $7,000 for those under 50 and $8,000 for those 50 and older. Whether you can contribute directly — and how much you can contribute — depends on your tax filing status and annual income.

For 2024, if your modified adjusted gross income (MAGI) is below $146,000 (single filers) or below $230,000 (married filing jointly), you can contribute the full amount the IRS allows to a Roth IRA. At incomes above those limits, the amount you can contribute becomes smaller until you are no longer eligible.

2024 Roth IRA eligibility rules

For 2025, your MAGI must be below $150,000 as a single filer or below $236,000 as a joint filer to contribute the full amount to a Roth IRA.

2025 Roth IRA eligibility rules

» Learn more about Roth IRA contribution and income limits.

What types of Roth IRAs can you have?

Spousal Roth IRAs. A spousal Roth IRA is a Roth IRA held in the name of a married individual with little to no earned income. Contributions come from the working spouse’s income, and the account follows the same tax treatment and eligibility requirements as a normal Roth IRA.

Inherited Roth IRAs. An inherited Roth IRA is a Roth IRA that’s been inherited by the beneficiary after the original account owner dies. Beneficiaries of a Roth IRA are subject to unique rules compared with account holders, such as being subject to required minimum distributions (RMDs).

Rollover Roth IRAs. A rollover Roth IRA refers to a transfer of funds from an employer-sponsored account, such as a 401(k) plan, to a Roth IRA. This is often an option for people who leave their job and want to move the funds out of their employer-sponsored plan. It also can be done by high-earners who aren’t able to contribute directly to their Roth IRA (a strategy also known as a mega backdoor Roth).

Custodial Roth IRAs. A custodial Roth IRA is a retirement account owned by a minor but managed by an adult custodian until the minor reaches adulthood. There is no age limit for a custodial Roth IRA, but the minor must have a form of earned income.

Qualified vs. nonqualified Roth IRA distributions

Setting aside money in a retirement account — and not being able to access it for years — can feel intimidating.

With a Roth IRA, you can withdraw your original contributions whenever you want without owing any penalties or taxes, no matter how long your account has been open. That's because the money you put in is money you've already paid income tax on. When you withdraw money from a Roth IRA, the IRS always assumes your original contributions come out first.

If you’re withdrawing investment earnings, on the other hand, those withdrawals can fall under one of two categories:

• Qualified distributions. A qualified distribution from a Roth IRA is any withdrawal made without taxes or penalties.

• Nonqualified distributions: A nonqualified distribution from a Roth IRA is a withdrawal of investment earnings that incurs taxes, penalties or both.

In contrast to the traditional IRA, Roth IRAs do not have RMDs, in which account holders are required to withdraw a certain amount every year in retirement.

» Learn more about Roth IRA withdrawal rules

Roth IRA: The five-year rule

The five-year rule is a guideline that determines when account holders can withdraw earnings from their Roth IRA accounts without incurring taxes or penalties. Typically, the account needs to be open for five years — and the account holder must reach age 59 ½ — before earnings can be withdrawn without taxes and penalties. However, keep in mind that there are also specific five-year rules for Roth IRA conversions, inherited Roth IRAs and more.

» What to know about the five-year rule

Roth vs. traditional IRAs

The most distinctive difference between a Roth IRA and a traditional IRA is their tax treatment. However, many people have both types of IRAs as part of their retirement planning. You can also contribute to both in the same year as long as you qualify and don’t exceed the annual contribution limit.

» A full comparison of the Roth vs. traditional IRA.

Roth IRA: Benefits and drawbacks

Benefits of a Roth IRA

What makes a Roth IRA so attractive to investors is the potential tax savings:

• Long-term financial planning. If you think you'll be in a higher tax bracket when you retire than you are now, a Roth IRA may be more beneficial than a traditional IRA for long-term financial planning. The reason: You've already paid taxes on your contributions, so your withdrawals won’t result in extra taxes when it's time to enjoy your hard-earned money.

• Rising inflation. Inflation erodes the value of money over time. Giving your money an opportunity to grow tax-free can be extra lucrative when inflation is high.

» Learn more about Roth IRA pros and cons

Drawbacks of a Roth IRA

There are a few drawbacks of a Roth IRA:

• Five-year wait to withdraw earnings. Waiting five years from the tax year of your first Roth IRA contribution to withdraw earnings tax-free can be a drawback if you’re close to retiring. Withdrawing contributions before fulfilling the five-year rule could result in paying income taxes and a 10% penalty.

• No tax deductions. You also aren’t eligible for any tax deductions during the year you contribute, unlike with a traditional IRA. Tax deductions are helpful, as they can reduce your adjusted gross income and your overall tax bill for the year you contribute. You may qualify to claim the saver’s credit, which is a tax credit you get for making eligible contributions to an IRA. Keep in mind that the credit has income restrictions.

• Income limits. Roth IRAs have income limits, unlike traditional IRAs. If you make more than the allowed amount, you may not qualify for a Roth IRA.

Frequently asked questions

Should you contribute to a 401(k) or a Roth IRA?

You don't have to choose. As long as you're eligible for a Roth IRA, you can contribute to that alongside an employer-sponsored retirement plan like a 401(k). But that, of course, requires having enough money to contribute to both, which isn't always possible. If you need to choose one place to direct your dollars, read our comparison of 401(k)s vs. IRAs.

Can you lose money in a Roth IRA?

Yes. You can put your Roth IRA money in a variety of investments, and some of those investments may lose value, especially in the short term. It's important to understand your risk tolerance when choosing investments. Learn more about how to invest your IRA.

When should I contribute to my Roth IRA?

Your eligibility and contribution amount to a Roth IRA depends on your income amount. Occasionally, receiving a salary increase or bonus might push you into a higher income bracket, which could affect how much you can contribute to your Roth IRA or whether you can contribute at all. Depending on your circumstances, you can make contributions to your Roth IRA in incremental payments or pay a lump sum closer to the tax deadline.

If you accidentally overcontributed to a Roth IRA, you can withdraw the money to potentially avoid penalties and taxes.