A Roth IRA provides tax-free withdrawals in retirement, no matter how large your investments have grown. Combined with tax-free compounding on your investments, a Roth IRA can be a powerful tool to build your retirement nest egg early.
Anyone can open and start making contributions to a Roth IRA, at any age, as long as you have earned income. If you’re looking to open a Roth IRA, the good news is that it’s never too early to start saving for retirement. Here’s how to open a Roth IRA, step-by-step.
What is a Roth IRA? A Roth IRA is an individual retirement account that can be opened by anyone with earned income. Contributions (deposits into your account) are made with after-tax income (money you’ve already paid taxes on). You don’t receive any tax breaks when you contribute money to the plan, but the major advantage of a Roth IRA is that you can take tax-free withdrawals in retirement.
How to open a Roth IRA, step-by-step
Step 1: Figure out if you’re eligible
We mentioned that anyone with an earned income can open and contribute to a Roth IRA. But there is one caveat: you must not exceed the income limits set by the IRS each year. If you make too high of an income, your contribution limits can get reduced to zero. The contribution limit (the maximum you can deposit into your account each year) for 2023 is $6,500 if you’re under 50 years old, and $7,500 if you’re 50 years of age or older.
To be eligible to make the maximum contribution into a Roth IRA for 2023, your income must be $138,000 or less. If your income is higher than $138,000 but less than $153,000, you can still make contributions, but your limit gets reduced. If you make over $153,000, you cannot contribute at all.
- If your income is $138,000 or less: You can contribute up to the maximum Roth IRA contribution limit of $6,500 ($7,500 if age 50+).
- If your income is over $138,000 but less than $153,000: Your contribution limit gets reduced.
- If your income is over $153,000: You cannot contribute at all.
Fortunately, there’s an easy workaround if you exceed the income limits called the backdoor Roth IRA. You can put money into a traditional IRA instead (which has no income limits on contributions), and then immediately transfer the funds to your Roth IRA. Since the income limits only apply to contributions, and not transfers, this is a simple, legitimate way to bypass the income limit restrictions of a Roth IRA.
Step 2: Choose a Roth IRA plan provider
Your decision on who to choose for a Roth IRA provider should mainly be based on how you prefer to invest the funds in your account. Most providers will offer access to a wide variety of traditional assets like individual stocks, bonds, mutual funds, and ETFs. But choosing what to invest in and building your portfolio is where it can get tricky.
Also read: What Can I Invest In With a Roth IRA?
Do you want to choose your own investments and manage your own portfolio, or do you prefer hands-off investing?
If you’re interested in building your own portfolio, choose to go with an online brokerage that allows you to choose your own investments. If you’re going this route, some things that you may want to check for are:
- Annual fees
- Customer support
- Investment options
- Trading fees
If you’re not experienced with investing or want someone else to build and manage your portfolio for you, then choose to go with a robo-advisor instead. A robo-advisor is the simplest investment option as all you need to do is fund your account, set your risk profile and investment goals, and its algorithms will use your answers to build and manage your portfolio for you.
Many providers, like Carry, offer both options. You can compare the best Roth IRA providers here.
Step 3: Decide how much you want to invest
While there are no minimum contribution requirements with a Roth IRA account, some plan providers may have minimum investment requirements to start your account. As mentioned earlier, you can contribute up to a maximum of $6,500 into a Roth IRA for 2023, or up to $7,500 if you’re 50 years of age or older.
Remember that Roth IRA contributions are not tax deductible. You need to fund the account with income you’ve already paid taxes on, which you may need to use for other expenses. Determine how much you want to invest for this tax-year, and your investing goals for the future. A Roth IRA is a long-term investment account that ideally should only be withdrawn from in retirement. The money that you put into your account should be money you don’t plan on taking out for several years or decades into the future.
Step 4: Fill out the required paperwork and open your account
It’s actually quite simple (and fast) to open a Roth IRA online. With Carry, it takes under 10 minutes to open your account and make your first contribution and it can be done completely online with no paperwork required. For most Roth IRA plans, you’ll need to verify your identity with a photo ID, Social Security number, and connect your regular bank accounts so that you can transfer money to your Roth IRA.
Step 5: Make your first contribution and choose your investments
Once you’ve opened an account, you can immediately deposit money into it and start investing your funds once the money arrives. If you have another retirement account like an old 401k or a traditional IRA, you could even choose to rollover the funds into your Roth IRA. Transferring money from your bank or rollovers can take 3-5 business days.
Once the money is in your account, you can invest the funds how you like. You can start choosing your own investments or put your robo-advisor to work and let them build your portfolio for you.
Step 6: Set up recurring contributions
One of the most effective ways to save for retirement is to not have to think about it every month by setting up recurring contributions from your bank. Many providers will allow you to choose automatic contributions from your bank on a weekly, monthly, or annual basis. Since contributions to a Roth IRA are made with after-tax income, there’s no advantage to wait until the end of the year to make your contribution. The sooner you can start investing, the more you can leverage compound interest to grow your account.
The 3 major advantages of a Roth IRA
- Tax-free withdrawals: Because you pay taxes up front when you contribute, your withdrawals in retirement are tax-free no matter how large your investment gains may be.
- Withdraw contributions: You can withdraw your contributions only at any age without any penalties or taxes.
- No RMD: Most retirement accounts require that you start taking mandatory withdrawals once you reach the age of 73. A Roth IRA has no RMD rules and can be kept compounding tax-free as long as you’re alive.
About Roth IRA withdrawals
Once you put money into a Roth IRA, you can start to invest the funds. Most Roth IRA providers allow investments into traditional assets like stocks, bonds, mutual funds, and ETFs. But you can also choose to invest in alternative assets like precious metals, crypto, real estate, and startups through a special kind of Roth IRA, the self-directed Roth IRA.
As with most retirement plans, your money can compound tax-free. In other words, you don’t have to pay any capital gains when your investments make profits.
For example, let’s pretend you used your Roth IRA to buy 100 bitcoin when it was $100 and cashed out when it hit $10,000.
- 100 bitcoin x $100 = $10,000
- 100 bitcoin x $10,000 = $1,000,000
With a Roth IRA, you wouldn’t owe any capital gains tax on the $990,000 in profits and can be withdrawn completely tax-free. Or, it can be reinvested into other assets until you’re ready to start withdrawing from your Roth IRA.
Although investment gains like this are rare, it shows the true power of a Roth retirement account.
Also read: Roth IRA Withdrawal Rules
Who can open a Roth IRA?
Anyone with earned income can open a Roth IRA. Even minors can open a Roth IRA and start compounding their money tax-free from an early age through a custodial Roth IRA. A Roth IRA does have income limits that restrict high income earners from contributing. However, there’s an easy workaround to this rule by using a backdoor Roth IRA.