I Opened a Roth IRA. Now What Should I Do Next?

Opening a Roth IRA is a great step toward building tax-free retirement savings, but simply funding the account isn’t enough. To maximize its benefits, you need to understand contribution limits, choose investments wisely, and plan withdrawals strategically.

Contribution Rules

Knowing how much you can contribute—and whether you qualify—is key. For 2024, the maximum contribution is $7,000 if you’re under 50 and $8,000 if you’re 50 or older, thanks to the catch-up provision. Income limits may reduce or eliminate eligibility. For single filers, the phase-out range starts at $146,000 and ends at $161,000. For married couples filing jointly, it begins at $230,000 and phases out at $240,000.

If your income exceeds these limits, a backdoor Roth IRA may be an option. This involves contributing to a traditional IRA and converting those funds to a Roth IRA. However, if you have pre-tax funds in a traditional IRA, the pro-rata rule applies, making part of the conversion taxable. Calculating potential tax liability beforehand is crucial to avoid surprises.

Roth IRA contributions are made with after-tax dollars, so there’s no upfront tax deduction. However, contributions can be withdrawn anytime without taxes or penalties. While this flexibility is useful, withdrawing too much early can reduce long-term growth.

Investment Selections

How you invest within your Roth IRA determines its growth potential. Since withdrawals in retirement are tax-free, prioritizing high-growth investments is beneficial. Stocks, particularly index funds and ETFs, are popular choices due to historically strong returns. A fund tracking the S&P 500, for example, has averaged roughly 10% annual returns over decades.

Asset allocation plays a key role in managing risk. Younger investors might favor a stock-heavy portfolio, while those nearing retirement may shift toward bonds or dividend-paying stocks to reduce volatility. Target-date funds automatically adjust asset allocation as retirement approaches.

Diversification strengthens a Roth IRA portfolio by spreading investments across asset classes. International stocks, real estate investment trusts (REITs), and small-cap funds help balance risk and capture growth opportunities. REITs, for instance, provide real estate exposure while offering potential income through dividends.

Withdrawal Timeline

Understanding when and how to withdraw funds without penalties is essential. While contributions can be withdrawn anytime, accessing investment earnings requires meeting specific conditions. The IRS enforces a five-year rule, meaning earnings can only be withdrawn tax-free if at least five years have passed since your first contribution.

Once you turn 59½, both contributions and earnings can be withdrawn tax-free, provided the five-year requirement is met. Withdrawing earnings before this age generally incurs a 10% penalty and income tax. Exceptions exist, such as using up to $10,000 for a first-time home purchase, covering qualified education expenses, or paying certain medical costs. However, early withdrawals can significantly impact long-term growth.

Tax Filing Considerations

While Roth IRAs offer tax-free withdrawals in retirement, they still have tax implications. Contributions are not tax-deductible, so they won’t reduce taxable income for the year. Exceeding the contribution limit results in a 6% excise tax on the excess amount each year it remains in the account. To avoid this, excess contributions must be removed before the tax filing deadline or reclassified for the following year.

Tracking contributions ensures compliance with IRS rules. While Roth IRA contributions are not reported on a tax return, Form 5498, provided by the financial institution managing the account, documents contributions and fair market value. This form isn’t filed with the IRS but should be kept to verify the five-year qualification period.

Rollover Strategies

Managing retirement accounts sometimes requires transferring funds. A Roth IRA rollover can consolidate savings or convert pre-tax assets into tax-free income. Whether rolling over funds from a traditional IRA, 401(k), or another retirement plan, understanding tax implications is crucial to avoid unnecessary costs.

Rolling over a traditional IRA or 401(k) into a Roth IRA triggers a taxable event, as pre-tax contributions and earnings are converted into an after-tax account. The amount rolled over is added to taxable income, potentially pushing you into a higher tax bracket. To manage this, some investors use a partial conversion strategy, spreading rollovers across multiple years to control tax liability. This can be useful for retirees in lower-income years or individuals earning less due to career changes.

If rolling over a 401(k) from a previous employer, check plan rules. Some workplace plans allow direct Roth conversions, while others require rolling into a traditional IRA first. Employer-sponsored Roth 401(k) accounts can be transferred into a Roth IRA without tax consequences, but employer-matching contributions made on a pre-tax basis must be separated and taxed if converted. Proper planning ensures rollovers align with long-term tax strategies while avoiding unnecessary penalties.