A Roth IRA is one of the two major types of individual retirement accounts (also known as IRAs). Investments held in a Roth IRA are allowed to grow and compound on a tax-deferred basis. However, to enjoy the tax benefits of a Roth IRA, you have to keep your money in the account until you reach “retirement age.” The IRS defines this as 59 1/2 years old.
These accounts allow everyday Americans to save for retirement on a tax-advantaged basis.
Money contributed to a Roth IRA brokerage account can be invested in nearly any stocks, bonds, mutual funds, or ETFs. If investments held in the account pay dividends or interest, no tax will be due on this income at the end of the year. And if you sell a profitable investment within a Roth IRA brokerage account, you won’t pay a dime in capital gains taxes.
You can save for retirement in a standard (taxable) brokerage account, but these tax benefits make Roth IRA accounts a more preferable choice for those who qualify.
There are some exceptions to the withdrawal restrictions. For example, you can withdraw as much as $10,000 from your IRA to use towards a first-time home purchase. You can take out any amount to use to pay for college expenses. And with a Roth IRA, you can withdraw your original contributions (but not your investment profits) at any time, and for any reason.
How does a Roth IRA work?
A Roth IRA is an after-tax retirement account. You contribute money that you’ve already paid taxes on, and withdrawals are tax-free (provided they meet certain requirements). A Roth IRA is designed to provide the owner with tax-free retirement income. This makes the most sense for people who are in a relatively low tax bracket now, and want to lock in their current tax rate.
It’s important to understand how a Roth IRA works before you start investing. Note that you can’t take a tax deduction for contributions you make to a Roth IRA. In contrast, you can take a deduction for money you contribute to traditional IRAs and most other retirement accounts.
The best Roth IRA accounts have a couple of unique features that many people find appealing:
- You can withdraw your Roth IRA contributions (but not any investment profits) at any time, and for any reason. You’ve already paid tax on this part of your Roth IRA. In the eyes of the IRS, the money is yours to do with as you please. This feature makes Roth IRAs more appealing to investors who don’t want to tie their money up until they’re almost 60.
- Roth IRAs don’t have required minimum distributions, or RMDs, after you turn 72.
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