What are Roth individual retirement accounts?
Roth individual retirement accounts (IRAs) offer no up-front tax breaks. However, withdrawals of earnings as well as principal (with some restrictions) are not taxed.
A Roth IRA is a form of an individual retirement account in which contributions are made with after-tax earnings. Eligibility is limited by income. There’s still a big tax break: contributions are allowed to accrue tax-free in the account, and withdrawals are not taxed under normal circumstances. In 2015, 20.3 million people, representing 16.3 percent of all US households, owned a Roth IRA.
Eligibility and Contribution Limits
Only people with incomes under specified limits are eligible to contribute to a Roth IRA. In 2017, the contribution limit for IRAs is the lesser of $5,500 ($6,500 for individuals over age 50) or the taxpayer’s taxable compensation. The contribution limit falls once household income exceeds certain thresholds and eventually reaches zero (table 1).
Investors are allowed to withdraw their contributions (but not investment returns earned on those contributions) at any time without being subject to tax. However, to receive tax benefits on investment returns, withdrawals must be qualified distributions, meaning that funds were withdrawn 5 years after the first contribution was made and after the contributor reaches age 59 years and 6 months, dies, becomes disabled, or makes a qualified first-time home purchase. Nonqualified distributions do not satisfy the above conditions and are therefore taxed and subject to a 10 percent penalty tax. There are several exceptions to the penalty for the early withdrawal of investment earnings.
Holden, Sarah, and Daniel Schrass. 2015. “The Role of IRAs in U.S. Households’ Saving for Retirement, 2014.” Washington, DC: Investment Company Institute.
Topoleski, John J. 2015. “Traditional and Roth Individual Retirement Accounts (IRAs): A Primer.” Washington, DC: Congressional Research Service.