Are you considering opening and contributing to a Roth IRA for the first time? The Roth IRA account works a little bit differently than other retirement plans. It has many unique tax advantages not available with other accounts. Any individual with earned income during a tax year can make contributions to a Roth IRA, regardless of their age, as long as they don’t exceed the annual income limits. Here’s every tax advantage of beneficial feature of a Roth IRA.

Table of contents

Benefits and tax advantages of a Roth IRA

  1. Tax-free compounding
  2. Tax-free withdrawals
  3. No age limits
  4. Withdraw contributions without penalties
  5. No required minimum distributions
  6. Backdoor Roth IRA
  7. Ability to invest in alternative assets with a self-directed account

Also read: Roth IRA vs Traditional IRA

Let’s go through each of them below.

Tax-free compounding

Tax-free compounding is common across most popular retirement plans, and not unique to just the Roth IRA. When you sell assets in your account for a profit, you don’t have to pay any capital gains tax. Instead, all earnings go straight back into your account where it can get reinvested.

Tax-free compounding is especially an advantage for a Roth retirement plan like the Roth IRA, because don’t owe any taxes when you make withdrawals in retirement.

Tax-free withdrawals

With a Roth retirement plan, you don’t get any tax deductions when you make contributions to your account. All contributions are made with post-tax income (money you’ve already paid income taxes on). However, when you withdraw from your account in retirement, you don’t owe any taxes to the IRS. The whole amount in your Roth IRA is 100% yours, with zero taxes owed.

Comparatively, with a non-Roth retirement plan (typically referred to as a traditional pre-tax retirement plan), you get a tax deduction on your contributions, but your withdrawals in retirement are taxed as regular income.

For example, if you contributed $20,000 into your Roth IRA over the years, and it grew to a value of a $2 million by retirement, you can withdraw the entire $2 million for yourself, without owing any taxes to the IRS. However, if you contributed to a traditional IRA instead, you would have to pay income taxes when you withdraw.

No age limits for minors

A Roth IRA has no age limits; even minors can start saving for their retirement at an early age through a custodial Roth IRA. Starting to save for retirement as minors give children a head start because they can compound their money for years, or even decades, longer.

With a custodial Roth IRA, the account must be established for a minor by a custodian, who is usually a parent, guardian, or another responsible adult. The custodian is responsible for managing the account and making investments. Once the child reaches the age of majority (either 18 or 21 years old depending on the state), the account is fully transferred over to them.

Withdraw contributions without penalties

With a traditional retirement account like a 401k or traditional IRA, you’re not allowed to take out any money from your retirement plan before you reach the eligible withdrawal age of 59½. If you withdraw before the age of 59½, you’ll have to pay a 10% early distribution penalty plus income taxes on the amount withdrawn.

With a Roth IRA, you’re allowed to withdraw your contributions at any age (even before the age of 59½) without any penalties or taxes. There is no early distribution penalty for contribution withdrawals, and since you already paid income taxes on your contribution, you won’t owe any additional taxes on when withdrawing from the plan.

However, you can only withdraw your contributions without penalties. Earnings cannot be withdrawn until you reach the age of 59½ plus your Roth IRA must be at least 5 years old in order to pass the “5 Year Rule“.

No required minimum distributions (RMDs)

Unfortunately, the IRS doesn’t let you compound your money forever. Almost every other retirement has a required minimum distribution rule (also known as an RMD rule) that requires you to start taking distributions from your account once you turn the age of 73.

A Roth IRA does not have an RMD rule. You can keep compounding your money tax-free in your Roth IRA for as long as you’re alive. Because there’s no RMD, the Roth IRA is an effective vehicle for passing down assets to your beneficiaries.

Backdoor Roth IRA

A Roth IRA has income limits. If you make too much money, you cannot make contributions for the tax year that you’ve exceeded the limit.

Roth IRA income limits for 2023.

  • If your MAGI 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 MAGI is over $138,000 but less than $153,000, your contribution limit gets reduced.
  • If your MAGI is over $153,000, you cannot contribute at all.

To be able to make the full contribution into a Roth IRA for 2023, your income must be under $138,000.

Roth IRA income limits for 2024.

  • If your MAGI is $146,000 or less, you can contribute up to the maximum Roth IRA contribution limit of $7,000 ($8,000 if age 50+).
  • If your MAGI is over $146,000 but less than $161,000, your contribution limit gets reduced.
  • If your MAGI is over $161,000, you cannot contribute at all.

To be able to make the full contribution into a Roth IRA for 2024, your income must be under $146,000.

If you’re over the income limit, that means you cannot directly contribute to a Roth IRA. However, there’s another method you can put money into your Roth IRA called the backdoor Roth IRA. The traditional IRA has no income limits for contributions. Therefore, you can contribute to a traditional IRA instead, and then immediately rollover the funds into your Roth IRA. The income limit applies to contributions only, and rollovers are not effected.

Taxes involved with a backdoor Roth IRA

When you do a backdoor Roth IRA, you’ll have to pay taxes since a traditional IRA is funded differently than a Roth IRA.

  • A traditional IRA is funded with pre-tax income that you haven’t paid taxes on yet. Instead, the contribution amount gets deducted from your taxable income when you make a contribution.
  • A Roth IRA is funded with post-tax income that you already paid taxes on.

Therefore, to do the backdoor Roth IRA, you’ll have to pay income taxes when you convert funds from a traditional IRA to a Roth IRA. For example, if you convert $6,500 from a traditional to a Roth IRA, the $6,500 gets added to your taxable income for the year.

Invest in alternative assets

With a regular Roth IRA, your investment options are limited to traditional assets like stocks, bonds, mutual funds, and ETFs. However, there are many self-directed Roth IRA plans that allow you to invest in alternative assets like real estate, crypto, NFTs, and even startups and private equity.

Since a Roth IRA gives you tax-free withdrawals in retirement, investing in alternative assets that may potentially provide higher returns is a popular route for more risk-adverse investors.

What’s the contribution limit of a Roth IRA?

For 2023, you can contribute up to $6,500 into a Roth IRA. If you’re at least 50 years of age, you also get an additional $1,000 in catch-up contributions, bringing your total limit to $7,500. For 2024, you can contribute up to $7,000 ($8,000 if age 50+).

IRAs have smaller contribution limits than other retirement plans. For example, employees receiving a 401k can contribute up to $22,500 for 2023, or up to $30,000 if age 50+. For a solo 401k, business owners can contribute up to 10x more than a Roth IRA – $66,000 for 2023, or up to $73,500 if age 50+.

However, despite its smaller contribution limit, a Roth IRA is one of the easier retirement plans to open and can provide most working individuals with a tax advantaged savings account with tax-free compounding and tax-free withdrawals. If you have funds in another retirement plan, you can also rollover any amount into your Roth IRA.