4 Roth IRA Rules to Live By

To make the most of your Roth IRA, here are some rules you need to be clear on.

Maurie Backman
Maurie Backman
Jun 12, 2017 at 10:44AM
Investment Planning

The good thing about IRAs is that anyone who earns money is eligible to open one. But not all IRAs are created equal, and while there are plenty of good reasons to opt for a traditional IRA, Roth IRAs offer a number of benefits that traditional IRAs simply can't match. If you're thinking of opening a Roth IRA or, better yet, are already making steady contributions to an existing account, here are a few rules to follow.

1. Know your limits

Unfortunately, you can't just contribute as much as you'd like to an IRA. Whether you have a traditional account or a Roth, you'll be subject to annual contribution limits, which are currently set at $5,500 a year for workers under 50 and $6,500 a year for those 50 and older.

Envelope labeled "Roth IRA" with cash sticking out


Furthermore, while traditional IRAs don't impose income limits for contributions, if you earn too much money, you won't be eligible to directly fund a Roth. For 2017, the income limits for a Roth IRA are $133,000 if you're a single tax filer or $196,000 if you're a couple filing jointly. Being aware of these limits can help you avoid tax problems when making contributions, so pay attention to how much you're putting into your account and how much you're earning. Keep in mind that if you're not able to contribute to a Roth account directly, you still have the option to fund a traditional IRA and convert it to a Roth down the line -- so higher earners need not give up on opening a Roth.

2. You can access your principal contributions, but not your earnings, at any time without penalty

Because traditional IRA contributions are tax-deductible, your money must stay put until you reach age 59 1/2. Otherwise, you'll face a 10% early withdrawal penalty on whatever amount you remove prematurely.

Roth IRAs work differently, though. Since you don't get an immediate tax break for contributing to a Roth, you're given more flexibility with regard to withdrawing your money. In fact, you're allowed to make Roth IRA withdrawals at any time, and for any reason, without penalty, provided you only touch the principal amount you put in, not your gains.

Here's an example. Say you contribute $15,000 of your own money to your Roth IRA, which grows to $20,000 over time. If you need to get at that money a few years later and you're not yet 59 1/2, you're free to withdraw the $15,000 you put in penalty-free. If you touch that remaining $5,000, however, you could face a penalty. Thankfully, the IRS treats Roth IRAs withdrawals as first coming from contributions, so as long as you don't exceed the amount you initially put in, you won't risk being penalized.

3. Understand the consequences of removing funds early

The fact that you can withdraw your principal contributions from a Roth at any time isn't always a good thing. In fact, in some ways, it's one of the biggest drawbacks associated with a Roth.

Anytime you remove funds prematurely from an IRA, that's money you won't have available in retirement. In addition, you won't just lose out on the principal amounts you withdraw early, but the growth potential on that money as well.

Say you take a $20,000 Roth IRA withdrawal at age 40 and retire 25 years later. You won't just miss out on $25,000 of retirement income; you'll have $108,000 less if your investments generated an average annual 7% return during that time. And that could make a huge difference in the grand scheme of retirement.

4. The sooner you start contributing, the more your account stands to gain

Another major benefit of Roth IRAs is that they allow your money to grow completely tax-free. Also, because withdrawals aren't taxed in retirement, once you amass a certain sum in your account, it's yours to keep, no matter what. That's why it's critical to start funding your Roth IRA as early on in your career as possible. The more time you allow your money to grow, the more you'll get to take advantage of compounding.

The following table shows how much you might accumulate in your Roth IRA depending on the age at which you first start contributing:

If You Start Saving $400 a Month at Age...

Here's What You'll Have by Age 65 (Assumes a 7% Average Annual Return) ...












As you can see, if you begin funding your account at age 25, you can turn $192,000 in out-of-pocket contributions into a whopping $958,000 just by giving your savings ample time to grow. Now if you wait 20 years and cut your savings window in half, you'll still have a respectable $100,000 gain, but it's nowhere near as impressive as the $760,000 gain you'll achieve by getting started 20 years earlier.

Roth IRAs are among the most valuable retirement savings tools around, so it pays to read up on how they work. The more you familiarize yourself with these key Roth IRA rules, the better equipped you'll be to make the most of your account.