What Is A Roth IRA And How Does It Work?

I still remember the moment a colleague mentioned Roth IRAs when I was working as a bank teller in my early twenties. I was drowning in $30,000 of student debt, living paycheck to paycheck, and the idea of “tax-free retirement income” sounded like something only wealthy people worried about.

I was wrong. And I wish someone had explained it to me sooner.

If you’ve been wondering what is a Roth IRA and how does it work, you’re asking one of the smartest questions in personal finance. This single account has helped countless people—including many of my clients who started with almost nothing—build genuine, tax-free wealth for retirement.

Let me break it down the way I wish someone had explained it to me back then.

Understanding What A Roth IRA Is (And Why It Matters)

A Roth IRA is a retirement savings account that lets you invest money you’ve already paid taxes on. In return, your investments grow tax-free, and you can withdraw that money tax-free in retirement.

Read that last sentence again. Tax-free.

Unlike a traditional IRA, where you get a tax break now but pay taxes later, a Roth IRA flips the script. You pay taxes on your contributions today, then never pay taxes on that money again—not on the growth, not on the withdrawals, not ever.

This is fundamentally different from a regular savings account. With a Roth IRA, you’re not just saving money—you’re investing it for long-term growth. If you’re still figuring out the difference between saving and investing, here’s the short version: saving protects what you have, investing grows what you have.

And a Roth IRA? It’s one of the most powerful tools for growth that the tax code actually wants you to use.

How A Roth IRA Actually Works: The Tax Advantage Explained

Let me walk you through the mechanics, because understanding how a Roth IRA works is what separates people who use them strategically from people who miss out entirely.

You Pay Taxes Now, Not Later

When you contribute to a Roth IRA, you’re using money from your paycheck that’s already been taxed. There’s no tax deduction for your contribution—what you earn is what you invest.

This feels like a disadvantage at first. I get it. But here’s the trade-off that makes it brilliant.

Tax-Free Growth Over Decades

Once your money is inside the Roth IRA, it grows completely tax-free. Every dividend, every capital gain, every bit of compound interest—the IRS doesn’t touch any of it while it’s growing.

Here’s a real example. Let’s say you invest $7,000 annually for 30 years, earning an average 7% return. You’d end up with roughly $661,000. In a regular taxable account, you’d owe taxes on the gains every year. In a Roth IRA? That entire $661,000 is yours.

If you want to play with the numbers yourself, the SEC compound interest calculator is a fantastic tool.

Tax-Free Withdrawals In Retirement

This is where the magic happens. Once you hit age 59½ and your account has been open for at least five years, you can withdraw everything—contributions and earnings—completely tax-free.

Think about that. While your neighbors with traditional retirement accounts are watching a chunk of every withdrawal go to taxes, you’re keeping 100% of yours.

2025 Roth IRA Contribution Limits And Income Rules

The government puts caps on how much you can contribute and who qualifies. Here are the Roth IRA contribution limits and income rules for 2025.

Annual Contribution Limits

For 2025, you can contribute:

• $7,000 if you’re under 50
• $8,000 if you’re 50 or older (the extra $1,000 is called a “catch-up contribution”)

This limit applies to your total IRA contributions across all accounts. If you have both a Roth and traditional IRA, you can only contribute $7,000 total between them—not $7,000 each.

You also need earned income to contribute. This means wages, salaries, self-employment income, or other taxable compensation. Investment income and Social Security don’t count.

One workaround I love: spousal Roth IRAs. If your spouse doesn’t work but you earn enough, you can contribute to a Roth IRA in their name. This is huge for families with stay-at-home parents.

For the official breakdown, check the IRS contribution limits page.

Income Phase-Out Thresholds

Here’s where it gets a little complicated. Your ability to contribute phases out at higher incomes:

Single filers (2025):

• Full contribution allowed: MAGI under $150,000
• Partial contribution: MAGI between $150,000 and $165,000
• No direct contribution: MAGI above $165,000

Married filing jointly (2025):

• Full contribution allowed: MAGI under $236,000
• Partial contribution: MAGI between $236,000 and $246,000
• No direct contribution: MAGI above $246,000

If you earn too much, don’t worry—there’s a legal workaround called the “backdoor Roth” (more on that later).

The contribution deadline is your tax filing deadline. For 2025 contributions, you have until April 15, 2026. I’ve had clients make last-minute contributions and still get the full year’s benefit.

Roth IRA vs Traditional IRA: Which Is Right For You?

This is probably the most common question I hear: “Emily, which IRA should I pick?”

The honest answer? It depends on your situation. But here’s how I think about it after helping hundreds of clients with this exact decision.

Choose a Roth IRA if:

• You’re early in your career with a lower income now
• You expect to be in a higher tax bracket in retirement
• You want flexibility to access contributions if needed
• You’re focused on retiring early on modest income or pursuing the FIRE movement
• You want to leave tax-free money to heirs

Choose a Traditional IRA if:

• You’re in a high tax bracket now and expect a lower one in retirement
• You need the immediate tax deduction
• You don’t qualify for Roth IRA contributions due to income limits

For most younger investors I work with, the Roth IRA wins. Tax rates could increase over time, and decades of tax-free growth is incredibly powerful.

The Unique Benefits Of Roth IRAs You Won’t Find Elsewhere

Beyond the basic tax advantages, Roth IRA benefits include some features you won’t find in other retirement accounts.

No Required Minimum Distributions (RMDs)

Unlike traditional IRAs and 401(k)s, the IRS doesn’t force you to start withdrawing at age 73. You can let your money grow forever if you want—or leave it all to your kids.

Withdraw Your Contributions Anytime

Since you already paid taxes on your contributions, you can withdraw them at any time, for any reason, with no taxes or penalties. This makes a Roth IRA a surprisingly flexible account. I’ve had clients use it as a backup emergency fund (though I prefer they don’t touch it).

Tax Diversification In Retirement

Having both pre-tax accounts (like a 401k) and after-tax accounts (like a Roth IRA) gives you options. In retirement, you can strategically withdraw from different accounts to minimize your overall tax bill.

Estate Planning Advantages

When your heirs inherit your Roth IRA, they receive tax-free income (as long as the 5-year rule was met). With traditional IRAs, they’d owe income tax on every withdrawal.

How To Open A Roth IRA In 5 Simple Steps

Ready to get started? Opening a Roth IRA is easier than most people expect. The whole process takes about 15 minutes online.

Step 1: Verify Your Eligibility

Before you open an account, confirm you:

• Have earned income (wages, salary, self-employment)
• Fall within the income limits (MAGI under $165,000 single or $246,000 married)

If you’re unsure about the rules, the IRS official Roth IRA rules page has everything.

Step 2: Choose A Provider

The three providers I recommend most often are Fidelity, Vanguard, and Charles Schwab. All three offer:

• $0 account minimums
• Low-cost index funds and ETFs
• Excellent customer service
• User-friendly online platforms

Honestly, you can’t go wrong with any of them. Pick whichever feels most intuitive to you.

Step 3: Complete The Application

You’ll need:

• Social Security number
• Bank account information (for funding)
• Employment information
• Beneficiary designation (who inherits the account)

The application itself takes 10-15 minutes. It’s all online.

Step 4: Fund Your Account

You can start with any amount—even $50. Most providers let you:

• Transfer from a checking or savings account
• Set up automatic monthly contributions
• Roll over funds from another retirement account

I’m a huge fan of automatic contributions. Set it up once, then forget about it. That’s how wealth gets built.

When thinking about how much to save for retirement, remember: something is always better than nothing. Don’t wait until you can max out the account.

Step 5: Select Your Investments

Your Roth IRA is just the account—you still need to invest the money inside it. Otherwise it just sits there like cash.

For beginners, I recommend:

• Target-date funds: Automatically adjust as you approach retirement
• Total stock market index funds: Broad diversification, low cost
• S&P 500 index funds: Simple exposure to 500 largest U.S. companies

Understanding ETFs and mutual funds helps you make informed choices. Both work well in a Roth IRA—and the tax-free growth makes them even more powerful here than in a taxable account.

For those interested in income-generating strategies, dividend-paying investments inside a Roth IRA mean those dividends grow completely tax-free.

Common Roth IRA Questions And What You Should Know

After years of helping people open these accounts, certain questions come up again and again. Let me address them directly.

Can I have both a 401(k) and a Roth IRA?

Absolutely. And I recommend it. Your 401(k) (especially if your employer matches) should come first. Then fund a Roth IRA. This gives you both pre-tax and after-tax retirement money—the best of both worlds.

What if I earn too much for a Roth IRA?

There’s a legal strategy called the “backdoor Roth IRA.” You contribute to a traditional IRA (no income limits), then convert it to a Roth. It’s a bit more paperwork, but it works. The details are in IRS Publication 590-A.

Can I convert a traditional IRA to a Roth IRA?

Yes. It’s called a Roth conversion. You’ll owe income taxes on the converted amount, but then it grows tax-free forever. This can be smart in years when your income is lower than usual.

What investments can I hold in a Roth IRA?

Almost anything: individual stocks, bonds, mutual funds, ETFs, REITs, CDs. The main restrictions are collectibles and life insurance.

Should I contribute to a Roth IRA or pay off debt first?

It depends on the debt. High-interest credit card debt? Pay that off first. Student loans or a mortgage with reasonable rates? You can often do both. I’ve written about how to think through the pay off debt or invest decision.

What happens if I don’t use my contribution limit?

It’s gone for that year. You can’t carry unused contribution room forward. That’s why I encourage contributing as early in the year as possible—more time for tax-free growth.

Your Next Step: Start Today

Here’s what I want you to do: pick one action and take it this week.

• If you don’t have a Roth IRA: Open one. It takes 15 minutes.
• If you have one but haven’t contributed this year: Set up automatic contributions, even if it’s just $50/month.
• If you’re already contributing: Review your investments and make sure you’re actually invested, not just holding cash.

I spent years thinking retirement accounts were for people who had their lives together. I was wrong. A Roth IRA is for anyone willing to make small, consistent moves toward their future.

The best time to start was ten years ago. The second best time? Right now.