A Roth IRA is a tax-advantaged retirement account for residents of the United States. The main selling point for a Roth IRA is the ability to deposit after-tax money today, invest now, have that money grow, and then withdraw it tax-free you’re at least 59.5 years old.
As of 2021, there is a $6,000 a year limit for Roth IRA contributions if you’re under 50 years old – or $7,000 if you’re 50 years old or older. There’s also an income limit for who can contribution to a Roth IRA. You need to make under $125,000 if filing single, or under $198,000 if filing jointly.
Who Should Use a Roth IRA?
The “best” account to use would depend on your tax rate now and your tax when you withdraw funds. The future is difficult to know. I tend to assume that tax rates will remain roughly the same – adjusted for inflation.
Roth IRA’s are just of many accounts you can use to invest for retirement. Here’s a look at where they fit in the larger investing picture.
In other words, before considering a Roth IRA, you’ll first want to have an emergency fund, fund your 401(k) up to the company match, and pay off high-interest debt (credit cards).
After that the choice is between a Roth IRA and a Traditional IRA.
A rule of thumb for which account to use – Roth IRA or Traditional IRA – is to look at your taxes now and compare them with estimated taxes later:
| Situation | Best Account |
|---|---|
| Lower tax rate during retirement | 401(k) or IRA |
| Same tax rate during retirement | 401(k), IRA or Roth IRA |
| Higher tax during retirement | Roth IRA |
| You want the most flexibility later | Roth IRA |
The choice between these two likely isn’t going to make a major difference in your ability to retire or not. There are cases situations where you can retire and withdraw up to standard tax deduction and pay $0 in taxes when withdrawing from your 401(k)/IRA. In other words, this isn’t a clear-cut math problem unless you know all the variables (hint: you don’t)
My recommendation? You can’t go wrong with a Roth IRA. This is especially true if you have a 401(k). Having a 401(k) and a Roth IRA means you’re diversifying your tax-liability for later. This gives you options when you retire.
For example, a married couple could withdraw $24,000 from a 401(k) and $16,000 from a Roth IRA and pay $0 in taxes. That same couple would need to withdraw about 12% more from a Traditional IRA to have the same spending power.
Roth IRA’s have another superpower: you can withdraw any money you’ve contributed to them before you’re 59.5 years old. This is only your contributions – not growth due to investments. Ideally you wouldn’t want to do this unless it was an emergency, of you retired sooner.
In other words: Roth IRAs give you more flexibility in early retirement, and more flexibility in structuring your taxes.
Roth IRA Limits
Each year, there are two limits you’ll want to keep in mind when contributing to a Roth IRA:
The contribution limit is the amount you’re able to deposit into a Roth IRA for that tax-year. For 2021 that limit is $6,000 per person – or $7,000 if you’re 50 years old or older.
The income limit, based on your adjusted gross income (AGI), determines who can use a Roth IRA. If your income is above the income limit, you cannot contribute the full amount.
If you’re slightly above the income limit, then there’s a complicated formula to determine how much you can contribute. I haven’t been through the process of that personally, but I imagine in that case you’d want to wait until your taxes are ready for the previous year and make your Roth IRA contribution then.
Here’s a quick snapshot of the contribution limits and the income limits over the past few years.
| Year | Contribution Limit (Under 50) |
Contribution Limit (50+) |
Income Limit (Single) |
Income Limit (Jointly) |
|---|---|---|---|---|
| 2021 | $6,000 | $7,000 | $125,000 | $198,000 |
| 2020 | $6,000 | $7,000 | $125,000 | $198,000 |
| 2019 | $6,000 | $7,000 | $122,000 | $193,000 |
| 2018 | $6,000 | $7,000 | $120,000 | $189,000 |
If you “max out your Roth IRA” that means you’ve contributed up to the contribution limit for the year.
When Can I Make a Roth IRA Contribution?
Roth IRA contributions are made for the calendar year, but the date of the deposit doesn’t need to happen within the year.
For example, the 2020 Roth IRA contribution deadline is April 15, 2021 – or whatever your tax filing deadline without extensions.
If you log into your Roth IRA account to make a contribution, it will ask which year you want to make your contribution for. If you make this contribution between January 1st and April 15th, you’ll be able to contribute to either of these accounts – or both.
You can also make a Roth IRA contribution as early as January 1st for that year. Doing this allows you to get your money into the market sooner. Although there’s no guarantee that the market will grow in any given year, historically it’s grown over the long-term. If you max out your Roth IRA early, you’d advantage from more growth than if you invested at the end of the year.
