Here’s a Simple Guide to Everything You Need to Know About Roth IRAs

Set up a Roth IRA and contribute to your retirement fund
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Sixty-seven percent of Americans aren’t saving for retirement. That’s two-thirds of our friends, family and neighbors who are ignoring the inevitability that they won’t be able to work forever.

I’m not judging; I used to be one of them. And I really regret the years of saving that passed me by.

Why? Because Social Security’s not enough. And because the earlier you start investing, the less you have to invest.

The numbers are quite astounding, actually.

It’s all because of a little thing called compounding, which in this situation, means reinvesting your earnings each year — and, over time, getting exponential returns.

Don’t believe me? Take this example from Get Rich Slowly.

Let’s say you’re 20 years old and put $5,000 into a retirement account that earns an 8% annual average return. Even if you never put another penny into that account, it’ll grow to $180,000 by the time you retire at 65.

Or, put another way, let’s assume you want to retire at age 65 with $2 million (and again, earn an 8% average annual return).

According to GRS, here’s how much you’d need to invest:

  • If you start at age 20, you’ll need to invest $5,000 per year
  • If you start at age 25, you’ll need to invest $9,500 per year
  • If you start at age 40, you’ll need to invest $55,000 per year

OK, you say, those numbers are crazy. I’m convinced I should invest in my retirement. But what exactly does that mean? Where do I put that money?

Well, I’m here to help. One of the best places to invest your money is in a Roth IRA — and in this post, you’ll learn:

Feel free to click to a section you’d like to learn more about, or if you want to start from the beginning, let’s not waste any time…

What is a Roth IRA?

Want to have money in retirement? Then you’ve got to start investing… NOW.

And one of the best ways to do so is with an IRA (Individual Retirement Account). IRAs aren’t investments themselves; rather, they’re houses for your investment, kind of like a checking account.

But, unlike money in a checking account, the money within an IRA can be invested in the stock market — and over time, can earn exponentially bigger returns.

Roth IRAs are similar to traditional IRAs, with a few key differences. The biggest one? Roth IRAs are funded with after-tax dollars.

Traditional IRAs and 401(k)s are funded with pre-tax dollars. That means you don’t pay taxes on the money now — but will when you withdraw it.

Although that might sound appealing (who doesn’t want to save money now?!), think about this: You’ll hopefully earn more money as you age, which means you might be in a higher tax bracket by the time you retire.

Not to mention, who knows what the tax rate will be in, say, 40 years.

That’s where the beauty of the Roth IRA becomes apparent: Because you already paid taxes on the money, you’ll get to withdraw it tax-free.

And when I say “it,” I mean everything: both your contributions and the dividends you’ve earned.

So if you’re young and in a low tax bracket (15%-25%), many professionals say Roth IRAs are the way to go.

“If you’re maxing out your Roth IRA every year, you can have a million dollars in retirement that’s tax-free,” explains Sophia Bera, founder of Gen Y Planning and creator of Smart & Easy Retirement Planning for Millennials. “That’s pretty exciting.”

Even better, you might be able to get a tax credit just for investing. How? The Saver’s Credit,  which rewards you with free money when you save for retirement.

Depending on your income (AGI), the IRS will give you a tax credit (either 10%, 20% or 50%) on the amount of money (up to $2,000) you invest into a retirement plan.

Want to see if you qualify? Here’s the full chart from the IRS:


I know that’s a little confusing, so here’s an example.

Let’s say you’re a single parent (head of household) whose AGI is $26,000 per year. If you manage to invest $2,000 in a retirement account, the government will give you a tax credit for 50% of your contribution — meaning you’ll receive $1,000 off your tax bill.

Roth IRA vs. 401(k)

What if you’re lucky enough to have a 401(k) plan at work? Do you really need a Roth IRA, too?

I’d say it’s a good idea, because having both will offer you a diverse income when you retire.

Remember you’ll have to pay taxes on your 401(k) withdrawals in retirement — whereas your Roth IRA withdrawals will be tax-free.

So what should you do now? Invest in both.

If your employer offers a 3% match, for example, you should devote 3% of your paycheck to your 401(k) to get the full match, then try to max out your Roth IRA ($5,500 per year). If you magically have money left over after that, return to your 401(k).

Here are a few more differences between 401(k)s and Roth IRAs (if you don’t know what all the terms mean, don’t worry; we’ll be reviewing them later in the post)…

401(k) vs. Roth IRA

Funded with pre-tax dollars / Funded with after-tax dollars

Pay taxes on withdrawals / Pay no taxes on withdrawals

Comes out of your paycheck automatically / Must make your own investments

Can contribute $18,000 per year / Can contribute $5,500 per year

No income limits / Must earn under $118,000 to be eligible

Lowers your taxable income / Lowers taxes in retirement

Can’t withdraw money early / Can withdraw contributions at any time

Required minimum distributions / No required minimum distributions

Limited control over your investments / Complete control over your investments

Roth IRA Income Limits

Anyone who’s earned income in the United States can contribute to a Roth IRA — you don’t need to be a citizen.

The most common reason you wouldn’t be able to contribute to a Roth IRA is you earn too much money (boy do I look forward to that day!).

Wondering if that might be you? Here’s the IRS on who can contribute to Roth IRAs:

Image from the IRS

Basically, if you earn less than $118,000 — or you and your spouse earn less than $186,000 combined — you can contribute to a Roth IRA. (Note that eligibility is based on your modified adjusted gross income, which is slightly different than your AGI.)

If you have a super profitable year and go above the income limit, you won’t be able to contribute — but your Roth IRA won’t go anywhere. If, wonderfully, your income remains too high to contribute, you can look into a strategy called backdoor Roth IRAs.

The Roth IRA also doesn’t have age limits; unlike with traditional IRAs, you can contribute as long as you’re still working.

Roth IRA Contribution Limits

Although contribution limits are based on inflation — and thus subject to change — current rules state you can contribute up to $5,500 per year to your Roth IRA account.

If you’re 50 or older (and need to “catch up”), that amount increases to $6,500 per year.

No matter what, though, you can’t contribute more than you earn. So if you’re a student who only earned $1,500 last year, that’s the maximum you could contribute to your Roth IRA.

What counts as income? Wages, salaries, commissions, bonuses, etc — but not income from, say, a rental property.

One exception to this rule is for spouses who don’t work. If you’re married and filing jointly, you can create a spousal Roth IRA and contribute up to $5,500 per year to theirs and yours.

In order for your contributions to be counted for a certain tax year, you must make your contributions by April 15 of the following year. So if, for example, you want to max out your Roth IRA contributions for the 2016 tax year, the money must be in your account by April 15, 2017.

Withdrawing Money from a Roth IRA

One of the coolest things about the Roth IRA? Since you already paid taxes on your contributions, the IRS will let you take it out at any time — for any reason.

“Roth IRAs are a lot more flexible than other accounts,” explains Bera. “You can access your contributions before retirement — so it’s like a backup backup emergency fund.”  

Note we’re talking only about your contributions — not any dividends you’ve earned.

Let’s say you contributed $15,000 to your Roth IRA, and have earned $1,000 on your investment so far. You can take that $15,000 out at any time; no questions asked.

But if you want to pull that $1,000 of earnings — without taxes or a 10% penalty — it’ll need to be for a “qualified distribution.”

What makes it a qualified distribution? First, you must’ve opened the Roth IRA at least five years ago, and second, you must meet one of the following conditions:

  • You’re 59½, disabled or deceased
  • You’re using the money to:

    • Purchase your first home (up to $10,000)
    • Cover educational expenses for you, your kids or your grandkids
    • Pay for unreimbursed medical expenses (or health insurance if you’re unemployed)

If one of the above conditions applies, but your Roth is less than five years old, you’ll be able to avoid the early-withdrawal penalty — but might need to pay taxes on the earnings.

Although it’s wise to keep your Roth IRA earmarked for retirement, this flexibility is an attractive feature to many investors.  

“People are using Roth IRAs to fund their kids’ college because it doesn’t get factored into the FAFSA,” explains Bera. And if your kids end up getting scholarships or not attending college, you can let the money continue growing.

That’s because, unlike with traditional IRAs and 401(k)s, Roth IRAs have no required minimum distributions.

Translation? You can let the money sit in the account for as long as you like. If you end up not needing the money in retirement, you can even pass your Roth IRA on to your children. And because you already paid taxes on it, they won’t have to!

Advantages and Disadvantages of a Roth IRA

Though Roth IRAs have many advantages, they aren’t perfect. Here are the pros and cons of these retirement vehicles:

Advantages of a Roth IRA

  • Contributions AND earnings are tax-free
  • Contributions can be withdrawn penalty- and tax-free at any time
  • Earnings can be withdrawn penalty- and tax-free in certain situations
  • No mandatory withdrawals during retirement
  • Can contribute until you stop earning income

Disadvantages of a Roth IRA

  • Not tax deductible
  • Doesn’t lower your taxable income
  • Contribution limits of $5,500 per year
  • Can’t contribute if you’re a high earner

Still wondering if a Roth IRA or traditional IRA is a better fit for you?

This recent study from NerdWallet found that “Savers who make maximum annual contributions to an individual retirement account will net more after-tax retirement dollars — in some cases, well over $100,000 more — if they use a Roth IRA instead of a traditional IRA.”

Play around with this chart to see some examples:

How to Set Up a Roth IRA

Ready to set up your Roth IRA? I was hoping you’d say that.

Whether you go with an established broker or a robo-adviser, be sure to find a firm with low maintenance fees and low minimums.

Or, just go with one of our suggestions:


Not only is Vanguard an established and respected brokerage firm, it’s also known for its low fees.

My Roth IRA is with Vanguard, and I’ve had a great experience. Bera’s also a fan of the firm — as is The Penny Hoarder CEO Kyle Taylor!

To open a Roth IRA with Vanguard, follow these steps:

1. Visit Vanguard

2. Complete the online application, and fund your account with at least $1,000

3. A few days later, log into Vanguard and allocate that money (you can choose a “target-date fund,” which automatically invests in different index funds based on when you plan to retire)

If you get confused along the way, simply give Vanguard a call. I’ve found its customer service to be really helpful. (And if you need a way to save $1,000, here’s a strategy that worked for me.)


One of the most popular robo-advisers, Betterment is a good option for people who want to be as hands-off as possible (and are willing to pay an administrative fee of .25% for that convenience).

“Betterment makes it easy to start and invest,” says Bera. “It’s worth the fee — especially if it makes you start investing sooner.”

The best part is there’s no minimum deposit needed. So you could start investing with just $50 or $100.

The important thing isn’t where you open the account; it’s getting started, and then continuing to fund it.

To stay on track, I recommend setting up an automatic weekly or monthly withdrawal.

When I first started saving for retirement, I had Vanguard automatically withdraw $25 per week. It was painless, and over the years, it’s added up.

Now I have an automatic investment of $105 per week (the amount needed to max out my Roth IRA). When times get tough, I simply turn it off for a few weeks or months.  

Bera did something similar: “I used to set up a monthly contribution for $200 a month,” she says. “Then I’d see if I could use bonus income or tax return to make a one-time contribution and hit the max.”

If you need inspiration, think back to those stunning examples of compounding in the introduction. And remember to pay yourself first.

Why You Shouldn’t Wait to Invest in a Roth IRA

Investing in retirement isn’t as scary as it seems — and is so, so necessary.

As Bera says: “One of the best gifts you can give your kids is having enough money in retirement so they don’t have to take care of you.”

The sooner you start, the more rewarding it’ll be.

“You really have time on your side,” she says. “If you save $100 a week over 40 years, for example, and earn an 8% return, you’ll have a million bucks.”

Even if $100 per week sounds impossible to you right now, try for $100 per month.

“It’s about building good habits,” says Bera. “As you pay down debt, as you build up savings, move that money over to retirement. If you pay off a loan that was $200 a month, start a Roth IRA with that money.”

“When people are mindful about it, they can make some huge strides in their overall financial situation very quickly. If they aren’t, that money gets eaten up by normal cash flow.”

So be mindful. And start investing today.

Your Turn: Do you have a Roth IRA? Are you going to set one up now?

Susan Shain is a freelance writer and digital nomad. She covers travel, food and personal finance (basically, how to save money so you can travel more and eat more). Visit her blog at, or say hi on Twitter @susan_shain.