Open a Roth IRA Account

In the United States a Roth Individual Retirement Arrangement (or Account) (“IRA”) is a type of investment that offers participants a tax-free income after retirement, while allowing any investments in the account to grow tax-free. Opening an account involves first understanding whether a Roth IRA is appropriate for you, and then following a series of simple steps.

Steps

Comparing Traditional & Roth IRA's

  1. Learn the basics of an IRA. Quite simply, an Individual Retirement Account or IRA is a retirement savings account. Inside an IRA, you can hold stocks, bonds, mutual funds, treasuries, cash, or certificates of deposit. The main benefit of an IRA is that the investments you hold within it are allowed to grow tax-free.[1]
    • Investments are subject to a variety of taxes. For example, if you purchase a stock, the dividend income paid to you is subject to taxation. Similarly, if you buy a stock and sell it in a year for a profit, that profit is also taxed.
    • Within an IRA, any money you make from your investments can grow tax-free. This, in turn, allows your wealth to accumulate faster. In a taxable account, your returns would constantly be reduced by taxes owning.
    • IRA's are subject to limitations. For example, you could face a penalty charge of 10% for withdrawing any profits you have made before you turn age 59.5. In addition, there are limits to how much you can contribute annually to an IRA.
    • There are two main types of IRA's -- Traditional IRA's, and Roth IRA's
  2. Understand Traditional IRA's. A traditional IRA (Individual Retirement Account) allows you to make tax-deductible contributions. This means you do not need to pay any income taxes on income that you contribute to your Traditional IRA each year. For example, if you make $50,000 one year, and contribute $5,000 to your IRA, you will only pay tax on $45,000.[2]
    • You cannot withdrawn any contributions or profits before age 59.5, or else you are subject to a 10% penalty tax.
    • With a traditional IRA, you pay taxes when you withdraw the money, at which point they are taxed as if they are income. For example assume you turn 60, have $1 million in a Traditional IRA, and choose to withdraw $50,000 per year. That $50,000 would be taxed at whatever your income tax rate is at the time.
    • If you are under 50, you can contribute $5,500 per year, and if you are over 50 you can contribute $6,500 per year.
    • You must start making withdrawals before age 70.
  3. Understand a Roth IRA. Roth IRA's are similar to traditional IRA's with one key difference -- your Roth IRA contributions are not tax-deductible. This means if you contribute $5,000 of your income to a Roth IRA, you must pay tax on that income. The benefit is, unlike a Traditional IRA, you pay no taxes when you withdraw your money.[2]
    • This means if you withdraw $50,000 per year when you are 60, you receive $50,000 per year, completely tax-free. This benefits many people because incomes are often higher in old age, which means so are income taxes.
    • Roth IRA's also allow you to withdraw your contributions any time, tax-free. The key word here is contributions. Any profits from your contributions are subject to the 10% penalty tax unless withdrawn after 59.5.
    • For example assume you are 40 have contributed $20,000, which has in turn made $10,000 in profits, giving you a total account value of $30,000. You can withdraw $20,000 (your contributions) without facing penalty, but if you withdraw $30,000 you will face a penalty tax on your $10,000 in profits.
    • The contribution limits for a Roth IRA are the same as a traditional IRA.
    • Unlike a traditional IRA, you do not need to make withdrawals before age 70.
  4. Choose the correct account type for you. Certain types of IRA's are better for certain people. Generally, Roth IRA's a better choice if you think you will have a higher income in retirement, want access to withdraw your contributions before age 59.5, or want the flexibility to let your money to continue to grow tax-free after age 70. [3].
    • Since you do not pay tax on a Roth IRA when you withdraw the money after age 59.5, if you think you think your retirement income will be higher than your current income, a Roth IRA allows you contribute now when your income is lower, and avoid paying taxes at a higher tax bracket on your higher retirement income.
    • A Roth IRA also benefits those who need flexibility. For example, if your employment situation is unstable,or you foresee needing to withdraw money before age 59.5, a Roth IRA provides that flexibility.

Opening a Roth IRA Account

  1. Calculate your modified adjusted gross income (“AGI”). Your modified AGI is used in determining your eligibility for a Roth IRA and can be calculated using http://www.irs.gov/publications/p590a/ch02.html#en_US_2014_publink1000230988 provided by the Internal Revenue Service (“IRS”).
    • Alternatively, Google search "modified adjusted gross income calculator" for a variety of online calculators.
  2. Determine if you are eligible to open a Roth IRA. Not everyone is eligible. Roth IRAs have an income limit, and those who have an adjusted gross annual income higher than the maximum allowed income for their tax filing status may not open or contribute to a Roth IRA. To determine if you are eligible to contribute to a Roth IRA, use your modified AGI and the http://www.rothira.com/what-is-a-Roth-IRA provided by RothIRA.com.
    • Currently, if you are single, the amount of money you can contribute annually to your Roth IRA begins to phase-out if your income is between $116,000 and $131,000 annually.[4]
    • If you are married and filing your income taxes jointly, the amount you can contribute begins to phase-out if your income is between $183,000 and $193,000.
    • If your income is below $116,000, you can contribute the full $5,500 annually if you are under age 50 and $6,500 per year if you are over 50.
  3. Decide what type(s) of investments(s) you will purchase. You can purchase almost any investment you wish with a Roth IRA and should do some research to determine which investments are right for you. This will also help you choose where to open your account, as not all investment firms provide every type of investment option. Some guidelines when selecting investments include:
    • Stocks provide investors with the most potential for growth but also come with the most risk.
    • Money market (or cash) investments may be the least risky options, but they also provide the lowest rate of return.
    • The younger you are, the more risk you can afford to take, as your investments have more time to recover from market downturns.
    • Investments such as mutual funds and exchange-traded funds may be easier to research and evaluate.
    • For help choosing specific investments, you could use Fidelity Investments’ online tools to find and evaluate investment opportunities.
    • Do not be afraid to consult with a financial adviser or planner to explore investment options.
  4. Decide where you will place your account. Do some research and find the brokerage or financial institution most suitable for you. A good place to begin researching and comparing brokers is RothIRA.com's Account provider list. You may also want to check local banks and investment firms. Compare the following:
    • Account fees. Some brokers charge annual fees and others do not. Make sure you know in advance if the broker you choose charges annual fees and in what amount. Mutual funds charge management fees which may be "hidden," (not readily apparent), so read the prospectus before investing.
    • Minimum required contribution to open an account. Brokers may require an initial deposit of up to $2,500. Some companies will waive the initial contribution limit if you set up automatic, recurring contributions from your bank account. The maximum annual contribution for 2014 was $5500 ($6500 if you were age 50 or over).
    • Investment choices. Brokers typically offer a wide variety of investment choices. They should be willing to provide you with detailed information about those choices.
    • Tools and information provided. Many large brokerage firms offer online calculators, personal advice, and market commentary from experts.
    • Account funding options. Review the brokerage firm’s account-funding options to ensure that funding your account will be easy and hassle-free. Many firms offer the chance to transfer money directly from a personal bank account.
    • Locations. Some brokers are online only and do not offer local offices where you can get a face-to-face meeting with an account specialist or customer service representative. If you want to be able to speak with someone in person from time to time, choose a broker with a local office.
  5. Determine whom you will name as beneficiary. When opening any financial account, you should name a beneficiary to inherit the account in case something happens to you. Your brokerage firm or financial institution should provide you with a form to designate a beneficiary. Keep this information up-to-date, should your situation change. You don't want an ex-spouse claiming your hard-earned money, for example, when you want to leave it to your children.
  6. Apply for a new account. Most brokers allow new customers to apply for a new account online. However, if you have chosen a local broker with a brick-and-mortar office and wish to open an account in person, call for an appointment. To open an account online, visit the broker’s website and follow the onscreen instructions. Some information you may need to provide when opening an account include:
    • Your Social Security number and the Social Security number of your beneficiary.
    • Your checking or savings routing and account numbers.
    • Your income information. Brokerage firms and financial institutions use this to determine your eligibility for a Roth IRA.
  7. Begin making contributions to your account. Follow your brokerage firm’s instructions for making contributions. Keep in mind that there are yearly limits on the amount that you can contribute to a Roth IRA. You can use http://www.irs.gov/publications/p590a/ch02.html#en_US_2014_publink1000230988 provided by the IRS in publication 590.



Tips

  • You can contribute to a Roth only if you have taxable income from a job.
  • If you don't work but your spouse does, and you file a joint return, you may be eligible to contribute to a Roth or traditional IRA, as long as the working spouse earns enough that year to cover both contributions.
  • If you earn too much to qualify for a Roth, you may still be able to contribute to a traditional IRA. The contributions will not be tax deductible, and you will have to pay income taxes on your gains, but those taxes will be deferred until you begin withdrawals.
  • For complete information on basic investing techniques and help with choosing your investments, see Fidelity Investments’ publication Choosing investments that are right for you.

Warnings

  • You can contribute to a Roth only if you or your spouse have taxable income from a job.
  • You cannot contribute more to an IRA than you earn during that tax year.

Related Articles

Sources and Citations

  1. ↑ http://www.fool.com/money/allaboutiras/allaboutiras01.htm
  2. ↑ 2.0 2.1 https://investor.vanguard.com/ira/roth-vs-traditional-ira
  3. ↑ http://www.moneychimp.com/articles/rothira/rothintro.htm
  4. ↑ https://investor.vanguard.com/ira/roth-ira-income-limits
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