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The Roth IRA: What It Is and How It Works

The Roth IRA: What It Is and How It Works

| April 01, 2019
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What is a Roth IRA?

The Roth IRA was established in August of 1997 with the passage of the Taxpayer Relief Act of 1997. Named for the bill's co-sponsor, Senator William Roth of Delaware, this Individual Retirement Account (IRA) would be exempt from capital gains taxes; profits from investments in a Roth IRA would not be subject to income taxes. Unlike other tax-advantaged retirement accounts that allow for tax-deductible contributions, a Roth IRA is funded with after-tax contributions. So while there are no tax deductions in the year Roth contributions are made, Roth IRA owners are able to take advantage of tax-breaks later on. Withdrawals from a Roth IRA (providing they are qualified withdrawals) are made tax-free, and all of the growth that occurs inside a Roth is tax-free. 

Can anyone contribute to a Roth IRA?

Unlike traditional IRAs, Roth IRAs have certain income limits that determine who is eligible to make Roth IRA contributions. The income limits are based on an individual's modified adjusted gross income (MAGI) for that particular tax year. These limits typically change from year to year, and also operate on a sliding scale, with certain income levels allowing for reduced Roth IRA contributions. The good news is that you are able to contribute to both a Roth IRA and a traditional IRA in the same year- so long as you do not exceed the overall IRA contribution limit. For the 2018 tax year, the IRA contribution limit is $5,500, plus an additional $1,000 catch-up contribution if you are over age 50 (for a total of $6,500). The 2019 contribution limit is $6,000, plus the $1,000 catch-up contribution for individuals who are 50 years or older. 

The infographics below can be used to determine whether or not you are able to make Roth IRA contributions in the 2018 and 2019 tax years. 

What are qualified withdrawals?

Withdrawals from a Roth IRA are tax-free, providing the owner of the account is 59 1/2 years old and the account has been open for at least five years. Contributions that have been made to a Roth IRA can be withdrawn without penalty at any time. 

Unlike traditional IRAs, Roth IRAs have no required minimum distributions (RMD).

What are the differences between a Roth IRA and a traditional IRA?

Each type of IRA has its own specific rules and potential benefits. These differences are summarized in the table below.

Traditional IRA

Roth IRA

Maximum Annual Contribution

The lesser of 100% of earned income or $5,500 for single taxpayers and $11,000 for couples filing jointly for 2018*. An additional $1,000 "catch-up" contribution is permitted for each investor aged 50 and older who has already made the maximum annual contribution.

Same as traditional IRA

Income Thresholds for Annual Contributions

None, as long as the account holder has taxable compensation and is younger than age 70½ by the end of the year.

Single taxpayers with MAGI in excess of $133,000 and married couples filing jointly with MAGI in excess of $196,000 are not eligible in 2017. Income thresholds are indexed annually.

Deductibility of Contribution

Yes, if account holder meets requirements established by IRS.

No. Contributions are made with after-tax dollars.

Contributions After Age 70½

No contributions allowed after age 70½.

Contributions allowed after age 70½ if owner has earned income.

Required Minimum Distributions (RMDs) After Age 70½

Lifetime RMDs are required.

Not required during the original IRA owner's lifetime.

Taxes on Distributions

Distributions are taxed as ordinary income to the extent taxable. Withdrawals before age 59½ may also be subject to a 10% additional federal tax.1

Qualified distributions are tax free. Withdrawals from accounts held less than five years and before age 59½ may be subject to taxes and a 10% additional federal tax.1

Deciding on which IRA is best for you in any given tax-year depends on your income tax levels, retirement plans, and how you feel. Each IRA option offers its own distinct set of advantages and disadvantages. 

Making Roth Contributions to Your Employer-Sponsored Plan

A Roth contribution is an after-tax contribution made to a retirement savings account. In addition to Roth IRA contributions, you may also make Roth contributions to your 401(k), 403(b), or another employer-sponsored plan, providing such contributions are permitted by your employer. Roth 401(k) contributions may be a particularly good option for high-earning individuals who are not eligible to contribute to a Roth IRA, as there are no income limits for making Roth 401(k) or Roth 403(b) contributions.  

Just like a the Roth IRA, the withdrawals of your Roth contributions will be tax-free, because you will have already paid income taxes on the original contributionThese tax-free distributions follow the same rules as Roth IRA distributions; the account owner must be at least 59 1/2 years old, and the Roth 401(k) contributions must have been in the plan for at least five years from the time the first Roth contribution was made. 

Like your regular 401(k) contributions, you must begin taking minimum distributions (RMDs) from your Roth 401(k) account at age 70½. 

Should you open a Roth IRA?

There is no easy answer to the question "Should I be making Roth IRA contributions?" because no two people have the exact same financial situations. As with any financial consideration, careful consultation with a financial professional about what is best for you, is a good idea before you make your choice.

Have questions? Let's Talk.

Contact Anne


1IRA account holders (both traditional and Roth) may avoid the 10% additional federal tax on withdrawals before age 59½ only if they meet specific criteria established by the IRS. See Publication 590-A for more information.

Important Disclosures

This material is for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax-free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Future tax laws can change at any time and may impact the benefits of the Roth 401(k) and Roth 403(b). Its tax treatment may change.

Securities offered through LPL Financial, Member FINRA/SIPC.

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