What Is a Roth IRA?

When you’re saving for retirement, options abound. You’ve probably heard of a 401(k) and maybe an IRA. But what’s a Roth IRA?

A Roth IRA (and the Roth version of a 401(k)) allow you to save for retirement in a tax-advantaged way. When mixed with the traditional versions of these accounts, a Roth IRA can be a powerful tool in your retirement-planning arsenal.

What is a Roth IRA?

A Roth IRA is an individual retirement account

IRA stands for “individual retirement account,” which means that its an account you open on your own. Unlike a 401(k), which is only available to you if your employer offers one, most people can open an IRA. Like, your 401(k), an IRA allows you to save for retirement in a tax-advantaged way.

Roth IRA contributions are made with after-tax money

When you contribute to a Roth IRA you use after-tax dollars, meaning you pay tax today rather than getting a tax break when you make contributions like you would for a traditional IRA or 401(k). However, that also means you’ll never be taxed on the money again. It will grow tax-free and you can withdraw it tax-free as long as you’re 59½ or older and have owned your Roth account for at least five years. Note that contributions made to traditional IRA or 401(k) accounts will be taxed when you take the money out in retirement.

This makes a Roth IRA a particularly good option if you’re earlier in your career and in a lower tax bracket than you may be by the time you retire.

You can open a Roth IRA when you’re young (like really young)

The more time an investment has to grow, the more money you can make. As long as you have earned income in a year, you can contribute as much as you made that year to an IRA (including a Roth) up to $6,500 in 2023. That means even children could contribute any income they earn—perhaps from a summer job or babysitting.

You can take your contributions out at any time

Another special benefit to a Roth IRA is that you can always access your basis—the amount of money you’ve paid into the account—without paying additional taxes or penalties, regardless of how old you are. That’s different than traditional IRAs or 401(k)s—you would pay taxes and a penalty in most cases if you withdraw funds before you’re 59½. Keep in mind, however, that withdrawals could mean missing out on investment growth on that money.

There are limits to what you can contribute to a Roth IRA

One of the biggest drawbacks of the Roth IRA is its contribution limit in a given year. In 2023, the cap is $6,500 plus an extra $1,000 catch-up for those 50 or older. This is your max contribution across both a traditional and a Roth IRA, meaning if you have both types of accounts, your total contributions between the two can’t go over $6,500. (Compare that to the $22,500 contribution cap with a $7,500 catch-up for a 401(k).) If you contribute more than the limit in a given year, you may have to pay a penalty.

Also, your qualifications are based on your income and tax-filing status. If you earn more than $138,000 in a year ($218,000 if you’re married filing jointly), the maximum amount you can contribute each year starts to go down; once you earn $153,000 ($228,000 if you’re married filing jointly), you can’t contribute directly to a Roth IRA.

You can pass a Roth IRA to someone else if you die

Unlike other types of property, IRAs normally don’t pass to your heirs through a will. Instead, you can name a beneficiary they will pass to. So remember to designate a primary and contingent beneficiary (the person who gets the money if the primary beneficiary isn’t able to) for your account—and review it at least annually or whenever you experience a major life event like a birth or adoption, marriage, divorce or death. Without a beneficiary designation, whoever gets your IRA may lose some tax advantages.

Consider automating contributions to your Roth IRA

One final thing to remember about a Roth IRA is that, like with any savings account, you can make saving a no-brainer by automating your contributions with each paycheck. A Northwestern Mutual financial advisor can help you select the right investments for your Roth IRA and can show you how a Roth IRA can work strategically into your larger financial plan to help you minimize taxes both while you’re saving for retirement and once you’re in retirement.