Pros and cons of Roth IRA: Is Roth IRA right for you?

The Roth IRA is one of the best retirement accounts you can have due to its unique tax benefits. With the Roth IRA, you make contributions with after-tax wages, grow your account tax-free, and pay no tax on qualified withdrawals during retirement. Before you open a Roth IRA, however, there are some pros and cons of a Roth IRA you should know.

Here are the pros and cons of a Roth IRA and what you should expect when you open the account.

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Pros of Roth IRA

If you have never had a Roth IRA before or are new to retirement savings, you are probably not aware of the benefits of a Roth IRA. The good news is that I have created a complete list of Roth IRA benefits and listed them below.

1. You grow your account tax-free

One of the pros of a Roth IRA is that you will grow your retirement account free of taxes. By not paying taxes on your account growth, you enjoy the full effect of compounding interest on your account which helps you grow your retirement savings faster. To maximize your retirement savings, you must also avoid taking early withdrawals from the account. Early withdrawals trigger a 10% penalty and taxes on your earnings.

2. Roth IRA does not come with RMDs

Many retirement plans such as pre-tax 401(k), traditional IRA, Roth 401(k), etc. come with RMDs that kick in when you turn 73. Required minimum distributions or RMDs for short are mandatory withdrawals you must take from your account when you reach a certain age.

Most accounts require RMDs when you turn 73. Failure to take RMDs may result in a 50% penalty on the money you did to take out on time.

For example, if you were supposed to withdraw $3,000 for the year but only took out $1,500; you may end up paying $750 in taxes. This is because the money you did not take out is $1,500, and therefore, the tax will be 50%.

One of the Roth IRA benefits is that the account does not require RMDs as long as the account belongs to the original owner. Once the owner dies, however, heirs must start taking RMDs and the entire account must be distributed in 10 years. Some exceptions to this rule may apply.

3. Qualified distributions are tax-free

By default, distributions from your Roth IRA will be tax-free. But, to take advantage of this benefit, your distributions must be qualified.

Two main conditions must be fulfilled for a qualified distribution.

You must be 59½
You must have the account for 5 years

Any distributions you take outside of these conditions may result in a 10% tax penalty (if you are under 59½) and you may pay taxes on your earnings(if you did not own the account for at least 5 years).

4. Your heirs will inherit your Roth IRA tax-free

If you did not know this about a Roth IRA, your heirs will inherit your account tax-free. That is true. What makes Roth IRAs special when it comes to retirement savings is that the account gets passed on to your descendants tax-free. The only requirement is that heirs must start taking RMDs after the original account owner dies with some exceptions. Your descendants will not pay taxes on distributions from Roth IRA funds they inherited from you.

5. It is easy to set up a Roth IRA

Unlike other retirement plans that are complicated, a Roth IRA is very easy to open and manage. Most banks, brokerage firms, and other investment companies with retirement services offer Roth IRA accounts.

If you are not convinced yet, the following benefit of a Roth IRA will surprise you: It is easy to open a Roth IRA. Opening the Roth IRA takes 15 to 30 minutes depending on your provider and the whole process can be completed online. Keep in mind that the account provider must verify your identity. For this reason, you may be required to provide your social security number, address, full name, photo ID, mailing address, employer information, beneficiary information, etc.

After your account has been approved, you will need to fund the account and start investing. For more details on how to open a Roth IRA, refer to the following guide.

Guide: Opening a Roth IRA in 6 simple steps

6. Roth IRA comes with a lot of investment options

If you have a 401(k) plan, you will notice that you have a few investment options that come with the plan. These investments have been selected to minimize your risk which could also minimize your return on investment. Everything is set for you and you cannot invest in securities outside of your 401(k) plan.

One of the greatest benefits of a Roth IRA is that it comes with a variety of investments. With a Roth IRA, you can invest in bonds, stocks, mutual funds, index funds, and exchange-traded funds(ETFs) which can easily help you maximize your ROI.

7. Roth IRA fees are lower compared to 401(k) plans

One of the top benefits of a Roth IRA is that fees are lower compared to 401(k) fees. Due to many account providers and industry regulations, Roth IRA fees are much lower. In addition, you can reduce IRA fees much further by including passively managed funds in your portfolio.

8. There is no age limit to making contributions

Another benefit of the Roth IRA that makes it stand out is that there is no age limit to making contributions. As long as you earn an income and you meet the Roth IRA income limits, you can make contributions to the account regardless of your age.

In the case of married couples where one works but the other doesn’t, a spousal Roth IRA can be opened. The partner who works can make contributions to his/her partner’s account. This strategy allows the nonworking spouse to save for retirement. For 2024, the contribution limits to an IRA are $7,000 or $8,000 if you are 50 or older. If you are contributing to your spouse’s IRA, you can also make the same contributions. That is the total contributions to both IRAs more than $14,000 or $16,000 if you and your spouse are 50 or older.

To qualify for a spousal IRA, the couple must be married and filing jointly. In addition, one partner must earn no income for the spousal IRA to work.

In case you have a minor who earned an income, a custodial Roth IRA can be opened. A custodial IRA must be managed by a parent or a legal guardian until the child/minor turns 18 or 21 in some states. The minor must earn an income during the year contributions are made.

Cons of Roth IRA

If you are excited about the Roth IRA already, don’t open the account until you learn about the disadvantages of having a Roth IRA.

Here is a list of pros of a Roth IRA.

1. High-income earners may not contribute to the account

Even if the contribution to the Roth IRA will come from after-tax wages; you will not be eligible to make contributions if your income is higher than the income limits set by IRS. Your eligibility to make contributions to your Roth IRA will depend on your modified adjusted gross income(MAGI) and filing status.

If you are a high-income earner, you might not be eligible to contribute to your account during the year your income is higher than Roth IRA income limits. q

The following are the Roth IRA income limits in 2024.

If you are head of household or filing single and your income is under $146,000 you can contribute up to the limit. The amount you can contribute will start decreasing when your income hits $146,000 and becomes $0 when your income reaches $161,000. If your income is higher than $161,000, you will not be eligible to make contributions to your Roth IRA in 2024.

On the other hand, if you are married and filing jointly and your modified AGI is under $230,000, you can contribute up to the limit. When your income reaches $230,000, the amount you can contribute starts decreasing and becomes $0 when your income reaches $240,000.

If your income is higher than $240,000 when filing jointly, you will not be eligible to make contributions to your Roth IRA.

2. A 10% penalty and tax may apply to your earnings if you withdraw money early

By default, distributions from your Roth IRA are tax-free. But, you may encounter tax liability if you make early withdrawals from the account. Any distributions you take from a Roth IRA when you are under 59½ are considered early. For this reason, you may pay a 10% penalty. Additionally, you must own the account for at least 5 years to avoid taxes on your earnings. Your contributions can be withdrawn anytime free of taxes and penalties.

3. Roth IRA contribution limits are lower than employer-sponsored plans

One of the biggest cons of a Roth IRA is that it comes with lower contribution limits than employer-sponsored plans such as pre-tax 401(k) and SIMPLE 401(k) plans. For example, if you have a pre-tax 401(k) plan, you could contribute up to $23,000 or $30,500 if you are 50 or older in 2024. Large contributions allow you to invest more money and grow your savings faster.

For the Roth IRA, on the other hand, you can contribute up to $7,000 or $8,000 if you are 50 or older in 2024.

Low contribution limits on Roth IRAs make it difficult to grow your account faster.

You might also like: Roth 401(k) vs. Roth IRA: What is the difference?

4. No upfront tax benefits

Another con of a Roth IRA is that the account does not offer upfront tax benefits due to making after-tax contributions. If you are a low-income earner, you might find it difficult to max out your Roth IRA.

Roth IRA contribution limits in 2024

The Roth IRA contribution limits in 2024 are $7,000 or $8,000 if you are 50 or older.

Roth IRA contribution limits in 2023

The Roth IRA contribution limits in 2023 are $6,500. If you are 50 or older, you will get an extra $1,000 catch-up contribution. In other words, people who are 50 or older can contribute up to $7,500 to their Roth IRAs.

Roth IRA income limits in 2024

While the Roth IRA offers a lot of benefits, you might not be eligible to make contributions if your modified AGI is higher than the income limits set by the IRA.

Here are the Roth IRA income limits for 2024 to check your eligibility to make contributions.

If you are filing single and your income is less than $146,000 you can contribute up to $7,000. Once your income reaches $146,000 but lower than $161,000, you will be eligible to make a partial contribution. After your income reaches $161,000, you will not be eligible to make contributions to a Roth IRA for that year.

On the other hand, if you are married and filing jointly and your modified AGI is under $230,000, you can contribute up to $7,000 in 2024. When your income reaches $230,000 the amount you can contribute starts decreasing until it gets to $0 when your income reaches $240,000. For income higher than $240,000, you will not be eligible to make contributions to a Roth IRA for that year.