In this Roth IRA beginner’s guide, let’s understand why the Roth IRA is such a great retirement account so that anyone can follow it without prior knowledge of personal finance.

What Is A Roth IRA?

First, what is a Roth IRA? It is a tax-deferred account designed for you to save for retirement. If you are employed, you know about 401(k) or similar tax-deferred accounts. Most employers set them up on your behalf after you get a job.

But, a Roth IRA is separate from employer sponsored retirement accounts. You must set up a Roth IRA on your own outside of your workplace. And, yes, you can have both a 401(k) and Roth IRA.

So, once you set up your Roth IRA account, you can transfer money from your bank account immediately. The Roth IRA is one of the best tax-deferred retirement options out there. Why?

Because, when you deposit money into a Roth IRA, it grows and compounds tax-free until the day you retire. So, you pay zero taxes on anything you earn at a Roth IRA account. But also, you pay zero taxes when you withdraw funds out of it. That’s a big advantage compared to other options like traditional IRAs.

After-Tax Roth IRA Contributions Explained

The Roth IRA comes with one important caveat, though. When you deposit money into it, this money is after taxes. Meaning, contributions to a Roth IRA don’t lower your taxable income. In other words, you pay taxes first and then make contributions to your Roth IRA. This is unlike a traditional IRA account. Contributions to traditional IRAs are tax-free and tax-deductible.

Let me illustrate this concept with a very simple example. Suppose you earned $100,000 this year. Your tax rate is 20%. With a Roth IRA, you must pay $20,000 in taxes or 20% on your income. And then you set aside $5,000 to your Roth IRA.

However, contributions to a traditional IRA are before taxes and are tax-deductible. They lower your taxable income. So, when you make a $5K deposit to a traditional IRA, your taxable income goes down to $95K. So, you will pay less in taxes today with a traditional IRA account.  

But, there is a big advantage of going with a Roth IRA. After paying taxes on initial contributions, you won’t owe a cent to state or federal taxes later. With a traditional IRA, it is the complete opposite. When you withdraw funds in retirement, you pay taxes then.

So, it all comes down to this very important decision. Should you pay taxes now to avoid future taxes with a Roth IRA? Or, should you avoid taxes today, only to pay them later with a traditional IRA? I will come back to this comparison and help you decide what works best.

Roth IRA Contribution and Income Limits

Of course, a Roth IRA has income and contribution limits. For starters, you must be at least 18 years old. In 2026, the max you can contribute to a Roth IRA is $7,500. If you are 50 or older, you can make an extra catch-up contribution of $1,100 for a total of $8,600.

One important thing to remember about these limits is this. They are combined across all of your IRA accounts. If you have both traditional and Roth IRA accounts, you can make combined contributions to them only up to these annual limits.

But, there are also income limits for Roth IRAs. If you are single and your modified adjusted gross income is below $153,000, you can make the full $7,500 contribution. Above that, your max contribution starts to phase out. If your income is above $168K, you cannot contribute even a cent to your Roth IRA, period. Similar but higher income limits apply to married filing jointly. These income caps get adjusted each year with inflation.

Modified adjusted gross income is usually a combination of your wages and salaries. But, it can differ depending on your circumstances. I left a link to the IRS page that will help you calculate your modified adjusted gross income.

Where To Invest Roth IRA Money?

Surprisingly, Roth IRA accounts allow you to invest in a wide variety of assets. It could be individual stocks, bonds, mutual funds and ETFs. Choosing what to invest in will be your most important decision.

If I were you, I would keep it very simple. Invest in a combination of diversified stock and bond index funds. For instance, it could be:

• US equity exposure: the S&P 500 or total stock market index fund
• Bond exposure: total bond market index fund

You may also want to add an international stock fund to the mix.

Roth IRA Withdrawals Rules

First, it is important to distinguish your contribution amounts from earnings on contributions. When you deposit money, those are your original contribution amounts. But, you will eventually earn income on your contributions like dividends, interest and capital gains. Capital gains are income when the stock prices of funds go up.

The Roth IRA is a retirement account for a reason. The government doesn’t want you to touch it until you turn 59½ years old. Also, your account must be open for at least five years before making withdrawals.  

But, here is one awesome thing about the Roth IRA. It gives way more flexibility for penalty-free withdrawals. You can withdraw your original contribution amounts at any time, tax-free and penalty-free. No strings attached whatsoever.  

It is a different matter for earnings on your contributions, though. Withdrawing them after you turn 59½ with a 5+ year old Roth IRA account is penalty free and tax free. But, outside of that, you will have to pay federal and state income taxes. Not only that, an early withdrawal penalty of 10% applies on these earnings too. So, as you see, it is a very bad idea to withdraw all of your money from a Roth IRA before you turn 59½.

Here is the good thing about the Roth IRA. When you make withdrawals, you can choose to withdraw your original contributions and not earnings. That way, you won’t have to pay any taxes and that awful 10% penalty. At the same time, the earnings money can continue working for you tax-free.

Roth IRA Early Withdrawal Exceptions

But, as with many rules, there are exceptions. If you make withdrawals of your earnings not contributions, to cover expenses for special situations, you won’t face that ugly 10% penalty. You will still have to pay income taxes on the earnings part of your withdrawals.

Here is a list of some early withdrawal exceptions from the IRS that will avoid that 10% penalty. As you can see, it is a long one. Just to name a few of them:

• first-time home purchase (up to $10,000)
• birth or adoption (up to $5,000)
• qualified higher education expenses (no hard limit)
• qualified disasters (no hard limit)
• personal or family emergency (up to $1,000/year)

The last one is new from 2022. If you have expenses that qualify as unforeseeable, immediate and necessary, you can withdraw up to $1,000/year penalty free. Emergencies like auto repair, foreclosure or eviction qualify. But, paying for your routine credit card bills does not.

Why A Roth IRA Is Such A Great Retirement Planning Tool?  

With that, let me tell you the five reasons why I love the Roth IRA.

1. Easy To Open, Cheap To Maintain

First, opening a Roth IRA is very easy and takes only a few minutes. You are in full control of it and it is very inexpensive to maintain. Most Roth IRAs charge a minimal or no fees at all.
That’s a big advantage because other retirement plans may cost money. There are administrative, maintenance and other fees that subtract from your returns.

2. Withdrawal Flexibility

Second, is the withdrawal flexibility it gives, especially for emergencies. We saw that you can withdraw your original contributions tax-free and penalty-free any time.
You can’t do that with traditional IRAs or 401(k) plans. Things happen in life and sometimes you need to access your nest egg earlier than expected.

3. Not Subject To Required Minimum Distributions (RMD)  

Third, the Roth IRA is not subject to required minimum withdrawals. When you turn 73, the government will force you to withdraw money from your 401(k) and traditional IRAs. But, RMDs don’t apply to the Roth IRA.

If you saved more than you need by 73, you can leave your Roth IRA account to continue growing. It may not seem like something important now, but it may be in retirement.

4. Investment Flexibility

Fourth, Roth IRAs give you more flexibility on where to invest your money. This is especially true compared to 401(k) plans. 401(k) plans constrain you to work only with mutual funds and maybe certain ETFs. That’s not the case with Roth IRAs. You can invest in stocks, bonds and almost any ETF out there. Not that you should do that. But, in certain cases, having more options is better.

5. No Income Taxes In Retirement  

Fifth, once you pay taxes on initial contributions to your Roth IRA, you don’t owe anything to the federal or state government. This is a very attractive option if Uncle Sam or your state decides to jack up tax rates in the future.

Roth IRA vs. Traditional IRA Comparison  

But, the Roth IRA is not perfect. It has its own drawbacks. The main one is that you have to pay taxes today. Depending on your situation, this may not be optimal.

Instead of talking in abstract terms, let me show you a simple and very easy example to understand. Suppose that today, you decided that you can deposit only $5,000 from your income before paying taxes. You are deciding between a Roth IRA or traditional IRA account. Your tax rate is 20%.

With a traditional IRA, a $5,000 contribution is tax-deductible. This means that if you deposit exactly $5,000, it will grow tax free until the time of withdrawal. Now, what about the Roth IRA? Before you can deposit any money, you have to pay taxes at 20%. This means that effectively, you contribute only $4,000 if we take taxes into account.

Now, imagine that your investment in either a traditional or Roth IRA account grows at 10%/year. By the end of the 35th year, your Roth IRA balance will grow from $4K to $112.4K. But, because you deposited more to a traditional IRA, its account balance grew from $5K to $140.5K.

Suppose that you decided to withdraw everything after 35 years. With a Roth IRA, what you see is what you get. There are zero taxes on that $112K balance. But, with a traditional IRA, you have to pay taxes first. Let’s suppose that your tax rate is the same 20%.

If you net out 20%, actually, you arrive at exactly the same amount of $112.4K as with the Roth IRA. So, we see that it makes no difference between the Roth IRA or traditional IRA if your tax rate stays the same.

And this is where the Roth IRA disadvantage comes into play. If your future tax rate turns out to be lower for any reason, the traditional IRA will give you more bang for your buck. For instance, suppose you move to Florida or Tennessee where state taxes are zero. Or maybe your income will be lower in retirement. This will lower your tax rate. Suppose your tax rate goes down from 20% to 10%. After paying taxes, a traditional IRA will net you more money.

Related: How to Open a Trump Account and Claim Your Free $1,000

So, in a nutshell it all comes down to this. If your tax rate today is lower than in retirement, the Roth IRA wins since it will give you more money. But, the reverse is true too. If your tax rate today is higher than in retirement, a traditional IRA is a better choice. Of course, the final size of your account is only one of the factors to decide on which option to pick. Other things like flexibility of withdrawals could be important too.

The second disadvantage of a Roth IRA is its strict income limits. This applies to high income earners. You cannot contribute if your income exceeds those thresholds that we covered before. But, there is a loophole called the backdoor Roth IRA. It entails contributing first non-deductible, after-tax money to a traditional IRA. Then, you convert your traditional IRA balance to a Roth IRA.

Roth IRA Takeaways

On a final note, I would not go for a Roth IRA before maximizing your 401(k) employer match first. If you have a 401(k), your employer probably has something like a 50% match on the first 6% of your salary. So, if your salary is $100K and you contribute $6K, your employer will match that with a $3K. I would prioritize maximizing your match first and then think about a Roth IRA if you have room to save more.