Money goes in after taxes, grows tax-free, and comes out tax-free in retirement

A Roth IRA is a retirement savings account where you contribute money that has already been taxed. That money then grows without being taxed each year, and when you withdraw it in retirement, you pay no tax on the growth or the original contributions. The tradeoff is that you get no tax deduction when you put money in — unlike a traditional IRA, where contributions reduce your taxable income now.

The account itself is held at a bank, brokerage, or credit union. You decide what to invest the money in: stocks, bonds, mutual funds, or cash. Whatever you choose, the earnings accumulate tax-free inside the account. You control when and how much to withdraw after age 59½, with no required withdrawals during your lifetime.

Key Takeaways

  • You contribute money you have already paid income tax on, and you receive no tax deduction for that contribution.
  • Any earnings — interest, dividends, capital gains — grow inside the account without being taxed each year.
  • After age 59½, you can withdraw your contributions and earnings tax-free, with no required minimum withdrawals.
  • Income limits determine whether you can contribute the full amount each year; the limits change annually and depend on your filing status.
  • You can withdraw your contributions (not earnings) at any time without penalty, but early withdrawal of earnings triggers a 10% penalty plus income tax in most cases.

How contributions work and what the income limits are

You can contribute up to a set dollar amount each year if your income is below a certain threshold. For 2024, that limit is $7,000 per year if you are under 50, or $8,000 if you are 50 or older. The income thresholds — called phase-out ranges — vary by filing status and change each year. If your income exceeds the phase-out range, you cannot contribute the full amount, and above a certain point you cannot contribute at all.

The contribution must come from earned income: wages, salary, self-employment income, or taxable alimony. You cannot fund a Roth IRA with investment returns, Social Security, or retirement distributions. You can contribute for the current year until the tax filing deadline (usually April 15 of the following year), and you can also make a contribution for the prior year during that same window if you have not already done so.

Your employer cannot force you to open a Roth IRA or contribute to one. Some employers offer a Roth option within a 401(k) plan, but that is a different account with different rules. A standalone Roth IRA is opened at a financial institution of your choice.

What happens to your money while it sits in the account

Once money is in the Roth IRA, you choose how to invest it. The financial institution holds the account but does not decide what goes into it — you do. You might buy individual stocks, index funds, target-date funds, bonds, or keep it in a money market account. The growth depends entirely on what you choose and how the markets perform.

The key tax advantage is that you pay no tax on the earnings each year. In a regular taxable investment account, you would owe tax on dividends and capital gains annually. In a Roth IRA, those earnings compound without any tax drag. If your investments earn $50,000 over 20 years, that full $50,000 stays in the account — you do not send any of it to the IRS until you withdraw it, and even then you owe nothing if you follow the withdrawal rules.

When and how you can withdraw money

You can withdraw your contributions (the money you put in) at any time, for any reason, with no tax or penalty. If you contributed $5,000 and it grew to $7,000, you can pull out $5,000 whenever you want. The $2,000 in earnings is a different story.

You can withdraw earnings tax-free and penalty-free only if you are at least 59½ years old and have held the account for at least five tax years. The five-year rule applies to each Roth IRA separately if you have more than one, but it is measured from the year you opened your first Roth IRA, not from when you opened each individual account.

If you withdraw earnings before age 59½, or before the five-year holding period ends, you owe income tax on those earnings plus a 10% penalty. There are a few exceptions: withdrawals for a first-time home purchase (up to $10,000 lifetime), disability, medical expenses, or certain other hardships may avoid the penalty, but you still owe income tax on the earnings.

The difference between Roth and traditional IRAs

A traditional IRA lets you deduct your contribution from your income taxes in the year you make it, which lowers your tax bill now. But when you withdraw money in retirement, you pay income tax on the full amount — both your contributions and all the earnings. A Roth IRA does the opposite: you pay tax now, and withdrawals in retirement are tax-free.

Traditional IRAs also require you to start taking withdrawals at age 73 (as of 2023; this age changes under current law). Roth IRAs have no required withdrawals during your lifetime, which means you can leave the money untouched and pass it to heirs. If you do not need the money in retirement, a Roth IRA can be a better choice for leaving a larger inheritance.

The choice between them depends on whether you expect your tax rate to be higher or lower in retirement than it is now. If you think you will be in a lower tax bracket later, a traditional IRA may save you more money overall. If you think your rate will be the same or higher, a Roth IRA is usually better.

Converting a traditional IRA to a Roth IRA

You can move money from a traditional IRA into a Roth IRA in a process called a conversion. When you do, you owe income tax on the amount you convert in that tax year, as if you had withdrawn it. After the conversion, that money sits in the Roth IRA and grows tax-free going forward.

Conversions are useful if you have a traditional IRA and expect your tax rate to rise, or if you want to lock in a lower tax rate in a particular year. They are also a way to move money into a Roth IRA if your income is too high to contribute directly. There is no limit on how much you can convert, but the tax bill can be substantial, so most people work with a tax professional to plan a conversion.

What happens to a Roth IRA after you die

When you pass away, your Roth IRA goes to your beneficiaries — whoever you named on the account. They can withdraw the money, but the rules depend on whether they are a spouse or not. A spouse can treat the Roth IRA as their own, roll it into their own Roth IRA, or withdraw it under the beneficiary rules. Non-spouse beneficiaries must withdraw the money within 10 years of your death (under current law), though they can spread the withdrawals across those 10 years.

The major advantage for heirs is that they inherit the account tax-free. If you had $500,000 in a Roth IRA when you died, your beneficiaries receive $500,000 with no income tax owed. In a traditional IRA, they would owe income tax on the full amount. This makes a Roth IRA a powerful tool for leaving money to the next generation.

Frequently Asked Questions

Can I have both a Roth IRA and a traditional IRA at the same time?

Yes, you can have both. However, your total contributions to all IRAs combined cannot exceed the annual limit — $7,000 in 2024 if you are under 50. If you contribute $4,000 to a traditional IRA, you can only contribute $3,000 to a Roth IRA that year. The income limits for Roth contributions still apply separately.

What if my income is too high to contribute to a Roth IRA?

If your income exceeds the phase-out range, you cannot contribute directly. However, you can use a strategy called a "backdoor Roth" to convert money from a traditional IRA into a Roth IRA. This involves contributing to a traditional IRA (which has no income limit) and then converting it. Consult a tax professional, as this strategy has complications if you have other traditional IRAs.

Do I have to invest the money in stocks, or can I keep it in cash?

You can keep it in cash, in a money market account, or in any investment the financial institution offers. You are not required to buy stocks or take any investment risk. However, cash typically earns very little, so most people invest at least part of their Roth IRA to take advantage of the long-term tax-free growth.

What if I need to withdraw money before retirement?

You can withdraw your contributions anytime without penalty. If you need to withdraw earnings before age 59½, you owe income tax on those earnings plus a 10% penalty, unless you may have access to for an exception like a first-time home purchase, disability, or medical hardship. Check the rules for your specific situation before withdrawing.