When to open a Roth IRA?

Opening a Roth IRA can help you benefit from the tax-free growth of your retirement money. Here is how to get started with a Roth IRA.

3 min read

If you are starting your retirement savings journey, you may consider opening a Roth IRA. For most people, a Roth IRA offers multiple benefits that you won’t find in other retirement accounts, and it is a good option if you want greater flexibility with future distributions. But, when is the ideal time to open a Roth IRA?

The best time to open a Roth IRA is when you are young, preferably in your 20s when you start receiving paychecks. Opening a Roth IRA at 20 is better than 25, and an extra five years of contributions in your 20s can compound to several hundred thousand dollars by the time you retire. As long as you have earned income, you can start contributing to a Roth IRA and let your money grow tax-free over your lifetime.

When to open a Roth IRA

When you are young

When you are young and getting started with your career, you will be in a lower tax bracket than you will be later in your career. This makes a Roth IRA the right choice for you since you can pay taxes at the current rate, and avoid paying higher taxes when you retire. Also, you will use tax-free money to invest in stocks, bonds, mutual funds, and other investments available in a Roth IRA.

Although Roth IRAs do not offer a tax break as traditional IRAs do, you won't owe taxes on the investment earnings or when you take a qualified distribution from the account. Since you pay taxes when you contribute to a Roth IRA, the money will grow tax-free over the years, and you won't pay taxes again when you take a distribution in retirement.

An advantage that young investors have is time and the power of compounding. The Roth IRA retirement money will have a long time to grow through compounding, and small contributions can grow into a sizeable nest egg by the time you attain retirement age.

Lock in the current tax rate

If you expect to pay higher taxes when you retire, you can use a Roth IRA to lock in the current tax rate. This is the case with young investors in their 20s and 30s since their incomes will likely rise over the years, hence pushing them to a higher tax bracket. By paying taxes now, you avoid paying higher taxes when increased income pushes you to a higher tax bracket.

Take penalty-free withdrawals

A Roth IRA allows retirement savers to withdraw contributions made to the account at any time penalty-free. This means that, if you have contributed $20,000 to a Roth IRA over a 3-year period, you can withdraw the entire $20,000 penalty-free, regardless of your age. If the funds were held in a 401(k) or traditional IRA, you would pay taxes and penalties on the withdrawals if you are below age 59 ½.

The penalty-free withdrawals make a Roth IRA an ideal retirement vehicle for investors who want the flexibility to tap into their retirement account when faced with an emergency. You can use the Roth IRA as a backup emergency fund that you can dip into when you need money to pay for an unexpected cost. However, you should only tap into your Roth IRA when it is necessary.

You may also qualify to take penalty-free withdrawals of Roth IRA earnings if you are using the funds to make a first-time home purchase and pay medical expenses.

Avoid RMDs

If you have a tax-advantaged retirement account like a traditional IRA, you will be required to start taking the required minimum distributions (RMDs) based on the IRS life expectancy tables. These distributions will be subject to income taxes.

However, Roth IRAs do not require account owners to take RMDs when they reach age 72.  Since you contribute after-tax dollars to a Roth IRA, you can delay taking distributions even after you attain age 72.

Who is Eligible for Roth IRA?

The IRS requires that you must have earned income to qualify for a Roth IRA. Also, there are phased income limits that determine your ability to contribute to a Roth IRA.

In 2022, the Roth IRA income limits are phased out for people earning more than $129,000 for single filers, or $204, 000 for married couples. If the income exceeds $144,000 for single filers or $214,000 for married couples, these workers are ineligible to contribute to a Roth IRA.

If you exceed the Roth IRA income limits, you can use the backdoor Roth IRA strategy. This strategy lets you contribute to a nondeductible IRA and later convert it to a Roth IRA.

Where to Open Roth IRA

You can open a Roth IRA at most financial institutions and brokerages. If you are a do-it-yourself investor, you can open a Roth IRA with an online brokerage and pick your investments. Compare the online brokers based on their investment fees and trade commissions to know who has the best terms.

You can also opt to open a Roth IRA with Robo-advisor if you prefer to have someone pick an investment portfolio for you. The Robo-advisor builds and maintains the portfolio on your behalf, and you pay a small fee for the service.