Opening a Roth IRA can be an extremely smart move if you want to invest for retirement and save money on taxes later on. However, not everyone can open a Roth, so it is important to understand the Roth IRA rules and contribution limits – which is why you’re here!

Contributions to a Roth IRA are made with after-tax dollars, yet your money is allowed to grow and compound entirely tax-free. When you are ready to take distributions from your Roth IRA in retirement (or after age 59 ½), you won’t pay income taxes on your distributions, either.

Once you’ve understood what’s involved in opening a Roth IRA, take some time to compare top brokerage firms to find out which one is the right fit. With that in mind, we really like Betterment as a top choice for opening a Roth IRA account. Betterment is a robo-advisor that uses technology to help you find the right asset allocation and investments for your Roth IRA. They also offer intuitive retirement tools that can help you figure out how much you need to save each month or each payday, and they do it all for a flat .25% management fee.

How Much Can You Contribute to a Roth IRA?

For 2020, standard Roth IRA contribution limits remain the same from last year, with $6000 being the limit any individual can contribute. In addition, plan participants ages 50 and over have a limit of $7,000, which is commonly referred to as the “catch up contribution.” You can also contribute to your IRA up until tax day of the following year.

Contribution Year 49 and Under 50 and Over (Catch Up) 2020 $6,000 $7,000 2019 $6,000 $7,000 2018 $5,500 $6,500 2017 $5,500 $6,500 2016 $5,500 $6,500 2015 $5,500 $6,500 2014 $5,500 $6,500 2013 $5,500 $6,500 2012 $5,000 $6,000 2011 $5,000 $6,000 2010 $5,000 $6,000 2009 $5,000 $6,000

Where to Get Help Opening an Account

You can open a Roth IRA account with almost any brokerage account, but they don’t all offer the same selection of investments to choose from. Some brokerage firms also offer more help creating your portfolio, and some charge higher (or lower) fees.

That’s why we suggest thinking over the type of investor you are before you open a Roth IRA. Do you want help creating your portfolio? Or do you want to select individual stocks, bonds, mutual funds, and ETFs and create your own?

You should also check for investing fees as you compare firms, as well as the types of investments each account offers. We did some basic research for you to come up with some of the best brokerage firms to open a Roth IRA, and here’s what we found.

$0 per trade

$9.95 mutual fund

$0 set up

$0 annual open account

$0 per trade

$0 mutual fund

$0 set up

0.25% – 0.40% account balance annually Open Account

N/A per trade

N/A mutual fund

$100 set up (< $5,000)

$0 annual open account

How Roth IRAs Work

Roth IRAs work differently than other types of retirement accounts that afford a tax benefit upfront. As we mentioned already, these accounts are funded with money you’ve already been taxed on, and you also get the benefit of having your money grow tax-free all along. When you reach age 59 ½, you can begin taking distributions without paying income taxes on money you’ve accrued as well, which could lead to significant savings if your tax rate is higher later in life.

Another interesting detail to note about Roth IRAs is the fact that you can withdraw your contributions at any time without penalty, just not your earnings. For that reason, many people use a Roth IRA as a sort of “emergency fund” that they can access if they need money for college tuition, medical bills, or surprise expenses that pop up.

Personally, I think you should use your Roth IRA to save for retirement. After all, who wouldn’t want access to tax-free money later in life? Still, it’s nice to know you can access your Roth IRA contributions at any time without penalty if you need to.

Roth IRA Rules You Need to Know About

Here’s the thing about opening a Roth IRA: not everyone can use this type of account. There are income guidelines that must be followed for starters, and it’s even possible to have an income so high you can’t use a Roth IRA at all.

We’ve included all the important Roth IRA rules you need to know about below, so keep reading to find out whether you’re eligible for this account, and if so, how much you can stash away.

Who Qualifies?

We already mentioned how most people can contribute $6,000 across their IRA accounts in 2020, or $7,000 for those ages 50 and older. Anyone who earns an income is eligible to open a Roth IRA, and you can contribute the full amount of your income within a year to your account, up to annual limits.

Are You Required to Take Distributions?

Roth IRA accounts come with a few unique benefits outside of future tax savings. For example, you do not have to take Required Minimum Distributions (RMDs) out of a Roth IRA at any age, and you can leave your money in your account for as long as you live.

You can also continue making contributions to a Roth IRA after you reach age 70 ½ provided you earn an income.

Phase Outs and Income Limits

One major downside of Roth IRA accounts is the fact that not everyone can contribute due to income caps. If you earn in certain income brackets, your Roth IRA contributions may also be phased out, meaning you cannot contribute the full amount. Here’s how Roth IRA income limits and phase outs work for 2020:

Married couples filing jointly can contribute the full amount to a Roth IRA provided their modified adjusted gross income (MAGI) is below $196,000. Those with incomes between $196,000 and $205,999 can contribute a reduced amount. Those with incomes over $206,000 cannot contribute.

Single tax filers can contribute the full amount to a Roth IRA provided their modified adjusted gross income (MAGI) is below $124,000. Those with incomes between $124,000 and $138,999 can contribute a reduced amount. Those with incomes over $139,000 cannot contribute.

Conversions

If you have another type of retirement account such as a traditional IRA or even a workplace 401(k), it might be tempting to convert this account into a Roth IRA. Known as a Roth IRA conversion, this move would require you to pay income taxes on your distributions now so you can avoid income taxes later on.

While that might sound aggressive and unnecessary, there are many scenarios where a Roth IRA conversion can make sense. If you’re not earning a lot of money in a specific year and you want to convert to a Roth IRA while paying an extremely low tax rate, then you could fork over the taxes now and avoid paying income taxes on distributions later in life when you’re taxed at a higher rate.

Since Roth IRA accounts don’t require you to take RMDs, moving your money into a Roth can also make sense if you don’t want to be forced into required minimum distributions like you would be with a traditional IRA or a 401(k) at age 72. With a Roth IRA conversion, you would create an opportunity where your money could grow and compound untouched for a much longer stretch of time, and even until you die.

Recharacterization

A recharacterization takes place when someone moves money from a traditional IRA to a Roth IRA, or from a Roth IRA to a traditional IRA. More specifically, recharacterization changes how specific contributions are designated depending on the type of IRA.

For example, maybe you believed your income would be too high to contribute to a Roth IRA in a specific year, but you found your income was actually low enough to contribute the full amount. If you had already contributed to a traditional IRA instead, a recharacterization could help you move your funds into a Roth IRA after all.

Of course, the opposite is also true since it’s possible to believe your income will be low enough to contribute to a Roth IRA but not find out you’re wrong until the end of the year, after you made your contributions. In that case, a recharacterization to a traditional IRA could make sense.

These moves can be complicated, and there may be significant tax consequences along the way. It’s best to consult with a financial advisor or tax specialist before you decide to change the designation of your IRA contributions and face potential tax consequences.

Penalties for Early Withdrawals

We already mentioned how you can withdraw Roth IRA contributions at any time without penalty, but you should know that there are some downsides if you need to withdraw your earnings ahead of retirement age. Specifically, you will face a 10% penalty if you remove earnings from your Roth IRA account before age 59 ½.

Some exceptions apply. For example, you can withdraw earnings from your Roth IRA account without paying a penalty if you’ve had the account for at least five years, and you qualify for one of these exemptions — you used the money for a first-time home purchase (up to a $10,000 lifetime limit), you are totally and permanently disabled, or your heirs received the money after your death.

Summary

Opening a Roth IRA is a great idea if you want to avoid taxes later in life, but you’ll want to start sooner rather than later if you hope to maximize this account’s potential. Remember that all the money you contribute to a Roth IRA will be able to grow and compound tax-free over time, so getting started now lets you leverage the power of compound interest to the hilt.

Before you open an account, you should definitely compare all the top online brokerage firms to see which ones offer the investment options you prefer along with fees you can live with. Also consider which firms offer the type of help and support you need, including the option to have your portfolio chosen for you based on your income, your investment timeline, and your appetite for risk.