Roth IRAs: How They Work and How to Use Them

How contributions are treated

Most tax-favored retirement accounts follow the same basic pattern: your contribution is deductible, it grows tax-deferred, and you pay tax when you withdraw it. A Roth IRA runs the pattern in reverse. There's never an up-front deduction for what you put in, but your money still grows tax-deferred, and, unlike every other option, qualifying withdrawals come out completely free of income tax.

For 2023, the annual Roth IRA contribution limit is $6,500, with an additional $1,000 catch-up contribution allowed for anyone 50 or older, bringing the total to $7,500. To contribute the full amount, you need at least that much in personal service income, and your modified adjusted gross income has to fall below $138,000 if single or $218,000 on a joint return; the limit phases out between $138,000 and $153,000 for single filers and between $218,000 and $228,000 for joint filers. Contributions to a traditional IRA reduce how much you can put into a Roth in the same year, though SEP and SIMPLE IRA contributions don't count against the limit.

You can also contribute to a Roth IRA on behalf of a spouse, subject to the same income limits, meaning a couple with combined earnings of at least $13,000 could contribute up to $13,000 between them. As with traditional IRAs, excess contributions are subject to a 6% penalty.

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How withdrawals are treated

You can take money out of a Roth IRA at any time, but whether tax or a penalty applies depends on the timing of your contributions and your withdrawal.

Qualified distributions are the best outcome: earnings, contributions, and conversion amounts all come out completely tax-free. To qualify, at least five years must have passed since your first Roth contribution (or since a conversion, for converted amounts), and at least one additional condition must be met: you're 59½, disabled, deceased (with the distribution going to your estate or heir), or the withdrawal is for a qualifying first-time home purchase, up to a $10,000 lifetime limit, for yourself, your spouse, or a child, grandchild, or parent of either of you.

Non-qualified distributions can trigger an additional 10% tax on early withdrawals, generally those taken before age 59½, unless an exception applies. Exceptions include disability, distributions to a beneficiary after the owner's death, qualifying first-time homebuyer costs, a series of substantially equal periodic payments, significant unreimbursed medical expenses, health insurance premiums paid after a job loss, costs that don't exceed qualified higher education expenses, an IRS levy on the account, or a qualified reservist distribution.

When a distribution isn't fully qualified, there's a specific order the IRS uses to determine what's taxable: regular contributions come out first (always tax-free), then conversion contributions on a first-in-first-out basis (with any previously-taxed portion coming out before the untaxed portion), and finally earnings, which are the piece most likely to trigger both tax and penalty. Distributions of converted amounts within five years of the conversion can trigger the 10% penalty even if that amount was already included in income in an earlier year, so timing conversions carefully matters.

If you inherit a Roth IRA, qualified distributions remain entirely tax-free to you. Non-qualified distributions, where the five-year holding period wasn't met, are taxable to you on the earnings portion just as they would have been to the original owner, though the early-withdrawal penalty doesn't apply to inherited accounts. A surviving spouse has an additional option: rolling an inherited Roth IRA into their own Roth IRA, which can extend the tax shelter and eventually convert non-qualified amounts into qualified ones. Roth IRA balances remain part of the owner's estate for federal estate tax purposes, the same as traditional IRA assets.

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Converting to a Roth IRA

Converting a traditional IRA into a Roth IRA turns what would otherwise be a taxable traditional IRA distribution into a tax-free Roth distribution down the road, and it's the feature that originally drove much of the interest in Roth accounts. Conversion is treated as a rollover regardless of which method you use to move the money.

There are three ways to convert: a rollover, where you receive a distribution and contribute it to a Roth IRA within 60 days; a trustee-to-trustee transfer, where you direct the traditional IRA's trustee to move funds directly to the Roth IRA's trustee; or a same-trustee transfer, where a single trustee simply redesignates the traditional IRA as a Roth IRA without opening a new account.

Beyond traditional, SEP, and SIMPLE IRAs, you can also roll amounts into a Roth IRA from a qualified pension, profit-sharing, or stock bonus plan (including a 401(k)), an annuity plan, a tax-sheltered 403(b) annuity, or a section 457 governmental deferred compensation plan, provided you follow the rollover rules that apply to that specific plan type.

The cost of converting is real: the converted amount is fully taxable in the year of conversion, except for any portion representing your after-tax investment in the original account. There's no early-withdrawal penalty on the conversion itself, but you are paying tax now in exchange for tax-free withdrawals later, a trade-off that can extend to your heirs as well.

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Undoing a conversion

Under the Tax Cuts and Jobs Act of 2017, once a traditional IRA contribution has been converted into a Roth IRA, it can no longer be recharacterized back into a traditional IRA. This closed off what used to be a common safety valve: converting, watching the market, and reversing the conversion if the account lost value before taxes came due.

Before that change, the ability to recharacterize meant that if your account fell from $180,000 at conversion to $140,000 later, you could undo the conversion and avoid being taxed on $40,000 more than you actually had. That option is no longer available for conversions made after 2017, which makes the decision to convert a genuinely irreversible one and worth thinking through carefully in advance, particularly around volatile markets.

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Withdrawal requirements

Unlike a traditional IRA, a Roth IRA has no required minimum distributions during the owner's lifetime; the RMD rules that force traditional IRA owners to start withdrawing at a certain age simply don't apply while you're alive, though certain RMD-style rules do apply to whoever inherits the account after your death. Also unlike traditional IRAs, you can keep contributing to a Roth IRA past the usual RMD age as long as you're still earning qualifying income.

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The retirement savings contributions credit

Also known as the saver's credit, this benefit helps lower and moderate-income workers offset the cost of contributing to a retirement account, whether it's a workplace plan, a traditional IRA, or a Roth IRA. To qualify, you need to be 18 or older, not a full-time student, and not claimed as a dependent, with 2023 modified adjusted gross income below $73,000 for joint filers, $54,750 for heads of household, or $36,500 for single filers and married individuals filing separately. These thresholds are indexed for inflation each year.

The credit runs 10% to 50% of your contribution, applied to the first $2,000 contributed ($4,000 for joint filers), for a maximum credit of $1,000 per person, up to $2,000 for a couple where both spouses contribute and qualify. Lower income within the eligible range produces a higher credit percentage. This credit stacks on top of any other tax benefit from the contribution itself, and IRA contributions made up until the following year's April filing deadline still count toward the current tax year.

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Using a Roth IRA in estate planning

Roth IRAs get no special break on estate tax, but they've become a common estate-planning tool anyway. The strategy is to build a sizable Roth balance, often through deliberate conversion of traditional IRA assets, specifically to pass to heirs, who can then take qualified distributions completely tax-free and continue stretching the tax shelter across their own lifetimes.

Whether a Roth conversion makes sense for you comes down to a comparison of your current tax rate against your projected future rate, and the same logic applies to your heirs' likely future rates if the goal is passing wealth forward. The higher the projected future rate, relative to today's rate, the more a Roth conversion tends to pay off; rising federal deficits are one factor some planners point to as a reason future rates could climb, though nobody can predict that with certainty, and there's no guarantee that today's Roth benefits will remain unchanged decades from now.

Because the numbers behind a conversion decision, and its long-term estate implications, are genuinely complex, this is an area where professional guidance is worth the cost before you act, not after.

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