Are You Falling for These 5 Roth IRA Myths?

Key Points

• Unlike a 401(k) or traditional IRA, Roth IRAs allow you to take tax-free withdrawals in retirement.

• Also know that you can withdraw contributions, but not earnings, at any time from a Roth IRA.

• High earners have workarounds that allow them to also contribute to a Roth IRA via a backdoor method.

• The $23,760 Social Security bonus most retirees completely overlook ›

Arguably, the best way to financially prepare for retirement is by taking advantage of retirement accounts. It's a way to ensure you're investing and saving for retirement, while getting a tax break for doing so.

With retirement accounts like a 401(k) or traditional IRA, the tax break happens upfront, with the chance to lower your taxable income for the year. However, with a Roth IRA, you receive a unique tax break that can go a long way. In a Roth IRA, you contribute after-tax money and then have the chance to take tax-free withdrawals in retirement.

Where to invest $1,000 right now? Our analyst team just revealed what they believe are the 10 best stocks to buy right now. Learn More »

The tax benefit with a Roth IRA is great, but it also comes with caveats that the other retirement accounts don't have. Below are five common Roth IRA myths that we're going to debunk to help clear up any confusion you may have.

Image source: Getty Images.

Myth 1: You need to be employed to open a Roth IRA

401(k)s are tied to employers, so you can't make contributions unless you're currently employed. If you were previously employed and made contributions, those continue to grow; however, you can't make new contributions while unemployed.

A Roth IRA isn't tied to an employer, so you can make contributions at any time, as long as it's from earned income. For example, paychecks, self-employment income, and tips are eligible, but interest income or Social Security is not.

Myth 2: You must wait until retirement to withdraw from your Roth IRA

The plan should always be to keep money in your Roth IRA until retirement (since it's a retirement account), but you don't have to do so. In a Roth IRA, you can withdraw your contributions, but not earnings, at any time without dealing with the early withdrawal penalty that you'd face with a 401(k) or traditional IRA.

For example, let's say you contributed $10,000 to your Roth IRA and the balance has grown to $12,000. In this case, you could withdraw the $10,000 at any time, but not the $2,000 you earned in interest. If you were to withdraw the interest, you'd owe taxes on it and face a 10% penalty unless it falls under one of the exceptions.

After you've turned 59-1/2 years old and have made your first Roth IRA contribution at least five years prior, you can withdraw earnings tax-free and without penalties.

Myth 3: Roth IRAs have required minimum distributions

With a 401(k) or traditional IRA, you're required to begin taking distributions in the year you turn 73 years old. These are called required minimum distributions (RMDs).

Since you've already paid taxes on the money you contribute to Roth IRAs, you don't have to worry about taxes when you make withdrawals in retirement. This removes the need for RMDs.

You can keep your investments and cash in a Roth IRA as long as you like, and many people do so with the intent of passing it on to their heirs, giving the money more time to compound and grow.

Image source: Getty Images.

Myth 4: Roth IRAs have limited investment options

One of my gripes with a 401(k) is that investment options are often limited because they're provided to you by your plan administrator. Some people appreciate the provided options because they remove the guesswork from choosing investments. However, for people who want more control over their investments, this can be restrictive.

Myth 5: High earners can't have a Roth IRA

There are income limits to be eligible to contribute to a Roth IRA. If you're single or the head of household, the limit is $165,000; if you're married and filing jointly, the limit is $246,000; and if you're married and filing separately, the limit is $10,000.

Fortunately, being above the income limits doesn't completely take away your chances of taking advantage of a Roth IRA. You can still do so via the backdoor method, which involves contributing to a traditional IRA (which doesn't have income limits) and then converting the account into a Roth IRA.

Going the backdoor route will require you to pay taxes on the amount you're converting, but it could be well worth it because of the tax-free withdrawals you'll be able to take in retirement.

The $23,760 Social Security bonus most retirees completely overlook

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income.

One easy trick could pay you as much as $23,760 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Join Stock Advisor to learn more about these strategies.

View the "Social Security secrets" »

The Motley Fool has a disclosure policy.