The opportunity to grow your retirement savings―and withdraw money when needed is the power and flexibility a Roth IRA can provide.

What is a Roth IRA?

A Roth IRA is an individual retirement account (IRA) funded with after-tax dollars. At any time for any reason, you can withdraw your contributions tax-free and penalty-free. Additionally, any earnings on investments can also be withdrawn tax-free and penalty-free, provided certain requirements are met.1

Roth IRAs are similar to traditional IRAs, with the biggest distinction being how the two are taxed. Roth IRAs are funded with after-tax dollars – this means that the contributions are not tax-deductible, but once you start withdrawing funds, the money is tax-free.

How Does a Roth IRA Work?

You can put money you’ve already paid taxes on into a Roth IRA. It will then grow, and when you come to withdraw once you retire, you won’t have to pay any further taxes.

A Roth IRA can be funded from a number of sources:

• Regular contributions

• Spousal IRA contributions

• Transfers

• Rollover contributions

All regular Roth IRA contributions must be made in cash (which includes checks and money orders) – they can’t be in the form of securities or property.

The Internal Revenue Service (IRS) limits how much can be deposited annually in any type of IRA, adjusting the amounts periodically. The contribution limits are the same for traditional and Roth IRAs. These limits apply across all your IRAs, so even if you have multiple accounts you can’t contribute more than the maximum.

Once the funds are contributed, a variety of investment options exist within a Roth IRA, including mutual funds, stocks, bonds, exchange-traded funds (ETFs), certificates of deposit (CDs), money market funds, and even cryptocurrency.

5 Steps to open a Roth IRA

A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. These include banks, brokerage companies, federally insured credit unions, and savings and loan associations. Generally, individuals open IRAs with brokers.

1. Make Sure You’re Eligible

Roth IRAs have income limits, which can reduce or eliminate your ability to contribute to a Roth. For 2023, the contribution limit is $6,500 if your modified adjusted income is below $138,000 (single filers) or $218,000 (married filing jointly). At incomes above that, your contribution limit begins to phase out, until it is eliminated completely at $153,000 for single filers and $228,000 for those married filing jointly.

Most people are eligible to contribute to a Roth IRA as long as they meet some basic requirements. These include earned income for the year (without exceeding the maximum limit) and a form of taxpayer identification, such as a Social Security number (SSN) or a tax identification number (TIN) – one of which you’ll need if you have earned income.

If you’re considering contributing to one, keep in mind that there are income limits based on your modified adjusted gross income (MAGI):

• For the 2023 tax year: An individual’s ability to contribute to a Roth IRA starts phasing out at $138,000 and disappears altogether at $153,000. For couples, the contribution is reduced starting at $218,000 and phased out altogether at $228,000.

• For the 2022 tax year: The phaseout range for an individual is $129,000 to $144,000. For couples, it is $204,000 to $214,000.

There are also limits to the maximum amount you can invest in a Roth IRA each year:

• For the 2023 tax year: You can contribute $6,500 to an IRA, plus another $1,000 if you are age 50 or older. If you have more than one IRA, such as a traditional tax-deferred account and a Roth account, the combined limit stays the same.

• For the 2023 tax year: The annual contribution increases to $6,000. If you are 50 years old or older, you can contribute an additional $1,000.

2. Decide Where to Open Your Roth IRA Account

Almost all investment companies offer Roth IRA accounts. If you have an existing traditional IRA, the same company can probably open a Roth IRA for you.

Ask these questions as you decide where to open the account:

• Is there a fee to open or maintain it?

• Does the company provide customer service online or by telephone?

• Does the company offer the types of investments you’re looking for, whether that means exchange-traded funds (ETFs), target-date funds, actively managed funds, or stocks and bonds?

• How much does it cost to trade? This is especially important if you plan to buy and sell frequently in your account.

3. Fill Out the Paperwork

Most banks and brokerages have webpages for Roth IRAs that you can visit to begin the process. You may be able to complete the entire application online, or you can speak to someone in customer service if you have questions.

You’ll need the following:

• A driver’s license or another form of photo identification

• Your Social Security number (SSN)

• Your bank’s routing number and your checking or savings account number so that you can transfer money directly to your new account

• The name and address of your employer

• The name, address, and SSN of your plan beneficiary (the person who will get the money in the account if you die)

Remember to keep your beneficiary designation up to date, especially after events like marriage, divorce, or the death of a beneficiary.

4. Choose Investments

The financial firm will help you open the account, but you’ll need to decide how you want to invest the money that goes into your Roth. There are three basic approaches to choosing investments for your Roth IRA.

• Design Your Own Portfolio

you’re a DIY type of investor, you can get that diversification on your own by building a portfolio out of index mutual funds and ETFs. To do that, you’ll want to decide how much of your money to put toward riskier investments, such as stock funds, and how much you want to keep relatively safe in, for example, bond funds and cash. This mix is called your asset allocation.

If you’re going to design your own investment portfolio within your Roth IRA, it’s important to pick investments based on your comfort level and your time horizon to retirement. Many people put more of their investments into bonds as they get older because bonds are more stable than stocks. On the other hand, stocks historically have produced higher returns over the long term.

New rules of thumb suggest keeping a sizable portion of stocks in your portfolio even as you get older. Many experts recommend buying two to six mutual funds or ETFs – some made up of stocks and others of bonds – and keeping a small percentage of your account in cash or cash equivalents, such as money market funds.

• Buy a Target-Date Fund or Life-Cycle Fund

These funds, which consist of a mix of stocks and bonds, are designed to automatically adjust over time, moving to safer investment choices as you approach retirement age. Some examples from well-known fund families are Fidelity Freedom Funds and Vanguard Target Retirement Funds.

If you buy a target-date fund, remember that it’s designed to be your entire retirement portfolio. It’s best to buy just one. Also, note that because of the management involved in these funds, their fees can be higher than those of other investments.

• Consult a Financial Advisor

Choose an advisor who works with a financial institution or another independent professional of your choice. Some people prefer to hire an advisor, such as a fee-only financial planner, to help them pick investments for their Roth IRA accounts. Others rely on free or paid guidance from the company that is the custodian of their account. Either way, ask questions so you know what you’re getting and whether it’s appropriate for your goals.

5. Choose how much you want to invest

How much do you need to open a Roth IRA? There generally isn’t a fee for opening a Roth IRA, but there may be other costs and requirements depending on your provider and selected investments. Some brokers and robo-advisors – but not all – may require a minimum amount to open an account with them, or charge trading commissions when investments are bought and sold.

Think about your budget, your time horizon, and investing goals, and consider investing only money you won’t need in the next five years. That way, you have time to ride out the highs and lows of the market.

You’ll also need money to buy investments in your Roth IRA. Some mutual funds may have a $1,000 or higher minimum investment, although future investments can be smaller. Mutual funds, and ETFS as well, could also charge expense ratios, and other fees as well. We‘ll talk more about how to invest your Roth IRA in

6. Set Up a Contribution Schedule

Once you figure out how much you can contribute, consider setting up automatic transfers. Not only do you avoid the hassle of initiating the transfer each month, but you ensure you’re saving regularly. (Also, some brokers waive their initial deposit requirement if you agree to automatic transfers each month.)

If your bank allows you to, you can set up monthly transfers from your bank account to your Roth IRA. Alternatively, you can decide to make an annual contribution as long as you still meet the income requirements. You can contribute to your Roth IRA as late as the tax-filing date for the following year, typically April. Remember, contributions to Roth IRAs are made with after-tax money, so there’s no tax advantage to waiting until the last minute to make your contribution. In fact, the sooner you contribute, the sooner that money will go to work for you.

Be sure you don’t contribute too much. Contributing more than the annual limit – $6,500 in 2023 ($7,500 if age 50 and older) – may leave you subject to an IRS penalty. Keep in mind that the contribution limit is for all your IRA accounts combined – if you have a Roth and a traditional, that limit is a total across both accounts.

The Spousal Roth IRA

One way that a couple can boost their contributions is the spousal Roth IRA. An individual may fund a Roth IRA on behalf of their married partner who earns little or no income. Spousal Roth IRA contributions are subject to the same rules and limits as regular Roth IRA contributions. The spousal Roth IRA is held separately from the Roth IRA of the individual making the contribution, as Roth IRAs cannot be joint accounts.

For an individual to be eligible to make a spousal Roth IRA contribution, the following requirements must be met:

• The couple must be married and file a joint tax return.

• The individual making the spousal Roth IRA contribution must have eligible compensation.

• The total contribution for both spouses must not exceed the taxable compensation reported on their joint tax return.

• Contributions to one Roth IRA cannot exceed the contribution limits for one IRA (however, the two accounts allow the family to double their annual savings).

After You’ve Opened Your Account

Be sure to read your regular account statements as You may want to buy and sell investments at that point to rebalance your account.

As markets rise and fall, the value of your investments will change over time. For example, let’s say you started the year with a portfolio that was 30% in bond funds and 70% in stock funds. You may find that at the end of a year, the portfolio has shifted. If stocks have declined in value, it may now be 40% bonds and 60% stocks. In this case, you may want to sell some bond fund shares and use the proceeds to buy more stock fund shares.

Remember If you’re going to design your own investment portfolio within your Roth IRA, it’s important to pick investments based on your comfort level and your time horizon to retirement. Many people put more of their investments into bonds as they get older because bonds are more stable than stocks. On the other hand, stocks historically have produced higher returns over the long term.