What Is a Roth IRA? Pros and Cons - MagnifyMoney

What Is a Roth IRA? Pros and Cons

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What is a Roth IRA? Beyond being a special kind of retirement savings magic, it’s a type of personal retirement plan that gives you multiple tax benefits, including tax-free growth and tax-free distributions during retirement.

However, not everyone qualifies to take advantage of everything Roths have to offer. That’s why we’re here to help you get up to speed on all the rules for Roth IRAs. We’ll also lay out all the Roth IRA pros and cons so you can make the most informed choice for your retirement savings goals.

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What is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) that allows you to contribute money after taxes toward your retirement savings. By making after-tax contributions, money in your Roth will grow tax-free.

How do Roth IRAs work?

Roth IRAs work much like traditional IRAs, but there are notable differences.

With a traditional IRA, you can make contributions and potentially deduct your contributions on your annual income taxes. This classifies your traditional IRA contributions as “pre-tax.” Your Roth IRA contributions, however, are made with money you’ve already been taxed on, such as with funds that land in your bank account after payday. This classifies your Roth contributions as “after-tax.”

So, while you don’t quite see the benefits of Roth IRAs in the current tax year as you do with a traditional IRA, you’ll enjoy other long-term benefits, like tax-free growth, no-penalty withdrawal of contributions and tax-free distributions — providing you meet certain conditions.

The short version? With a Roth, you’re trading tax deductions now for tax-free income during retirement.

Roth IRA pros and cons

  • Tax-free withdrawals
  • No mandatory withdrawals
  • No maximum age requirements for contributions
  • Ways to get one even if you don’t qualify
  • Limited penalties on early distributions
  • Contributions are taxed
  • Limits based on income
  • Earnings withdrawal restrictions
  • Some retirees might not benefit

Benefits of Roth IRAs

The benefits of Roth IRAs are pretty remarkable, including:

  • Tax-free withdrawals. Since you contribute to a Roth with after-tax money, you’ll enjoy tax-free withdrawals when you begin to take distributions.
  • No mandatory withdrawals. While traditional IRAs force you to take required minimum distributions (RMDs) the year after you turn 72, Roths have no mandatory withdrawals.
  • No maximum age requirements for contributions. When traditional IRAs force you to stop making contributions at age 70 1/2, you can contribute to a Roth IRA as long as you’d like.
  • Ways to get one even if you don’t qualify. While Roths have income limits, high earners could still use a conversion called a backdoor Roth IRA to enjoy a Roth’s benefits.
  • Limited penalties on early distributions. You can withdraw your contributions to a Roth IRA anytime, but withdrawing earnings before age 59 1/2 would only incur a 10% penalty.

Drawbacks to Roth IRAs

While Roth IRAs offer multiple benefits, they have some potential downsides:

  • Contributions aren’t tax-deductible. Since you’ve already paid taxes on the money you use for your Roth contributions, you can’t deduct your Roth IRA on your income taxes like you potentially can with a traditional IRA.
  • Limits based on income. Unlike traditional IRAs, Roths have income limits based on your modified adjusted gross income (MAGI) which could mean you likely won’t qualify if you’re a high earner.
  • Earnings withdrawal restrictions. To withdraw your Roth earnings without penalty, you must be at least 59 1/2 years old, and it must be five years since you first contributed to your Roth.
  • Some retirees might not benefit. If you end up in a lower tax bracket during retirement than during your working years, the tax-free withdrawals might not benefit you.

Should you open a Roth IRA?

The benefits of Roth IRAs, while notable, don’t necessarily translate into a Roth being the best choice for everyone. So how do you know if you should open a Roth IRA?

  • If you believe your retirement income will be lower than your current income, a traditional IRA might be better than a Roth.
  • Because of the income limits and the lack of tax deduction, a Roth IRA also might not be the right fit for you if your earnings are currently at a peak.

Additionally, you don’t have to choose just one type of retirement account for all your savings. For example, you may consider opening a Roth IRA after you’ve already maxed out your 401(k) contributions. Pairing a Roth IRA and a 401(k) can also offer you more tax flexibility in retirement.

Alternative ways to save for retirement

If a Roth IRA doesn’t seem like the right fit , or if your income disqualifies you, don’t worry. You can still keep your retirement savings on track with other types of retirement accounts.

  • Traditional IRA. Traditional IRAs allow you to make pretax contributions and your earnings grow tax-deferred. If you earn too much to contribute to a Roth or you’d prefer to defer paying taxes on your contributions, consider a traditional IRA.
  • 401(k). If your employer offers a 401(k) plan, make sure you’re signed up to participate. The high contribution limit exceeds those for a Roth, especially if you can afford to max it out. You can try opening a solo 401(k) or SEP IRA if you’re self-employed.
  • Roth 401(k). Roth 401(k) plans are like regular 401(k)s but funded with after-tax dollars. However, unlike Roth IRAs, Roth 401(k)s have no income limits — a definite benefit for high earners.

For those who qualify, a Roth IRA can help you enjoy a tax-free two-fer: tax-free growth and tax-free withdrawals. Before opening a Roth IRA, be sure to review the income limits to ensure you qualify. And if you need a bit of help deciding which IRA is right for you, we’ve got your back. Just use our Roth IRA vs. traditional IRA comparison guide to see how they both stack up.

Frequently asked questions

There’s no limit on the number and type of IRA accounts. The annual contribution limits for all IRAs are cumulative, however. So, if you have both a traditional and Roth IRA, your annual contribution might look like contributing $2,500 to your Roth and $3,500 to your traditional IRA, for a $6,000 total in 2022.

Since you make contributions to a Roth IRA with money that’s already been taxed, you can’t deduct your contributions on your annual income taxes. So a traditional IRA might be a better choice if you need the tax deduction and still want to contribute to an IRA.

Contributing as much as possible to your retirement accounts each year is wise. However, you might have other financial priorities like paying down high-interest debt that are more pressing than maxing-out your Roth IRA. Nevertheless, no matter how much you save each year, you’re taking a step toward a financially healthy retirement.