Roth IRA: An Overview


by

29 August,2011

You probably already know how important it is to save for retirement. Even times of economic turmoil and stock market drops, it’s a good idea to prepare for the future by building up your nest egg. One of the tools you can use to grow your wealth is the Roth IRA.

What is the Roth IRA?

This is an Individual Retirement Account. You contribute money to the account, and decide where you want the money invested. Over time, the money grows. Once you reach the age of 59 1/2, you can begin withdrawing your earnings from the account and using it to pay expenses. (With a Roth IRA, you can also withdraw the contributions at anytime, without penalty.)

Anyone who has earned income can contribute to an IRA; you don’t need to contribute through your company. The exception to the rule of having earned income comes in the case of a non-working spouse. If you are married filing jointly, you can make contributions into the IRA of your stay at home spouse.

Tax Advantaged Status

One of the great things about the Roth IRA is that it comes with a tax advantage: Your earnings grow tax free. This means that, when you withdraw your earnings, you don’t have to pay income taxes on them. This can be a real benefit if you are in a higher tax bracket during retirement.

However, since your earnings grow tax free, you don’t get a tax deduction now for contributions. You have to make contributions with after-tax dollars. With a Traditional IRA, you can get a tax deduction for your contributions. However, when you withdraw your money later, you have to pay income taxes on the withdrawals.

Income and Contribution Limits

The Roth IRA comes with income restrictions, though. No matter how much you make, you can contribute to a traditional IRA, even though your tax deduction phases out. With a Roth IRA, things are different. For 2011, if you are married filing jointly, your contribution starts phasing out when your annual income reaches $169,000. Once your income reaches $179,000 a year, you can no longer contribute to a Roth IRA. For single people, the phase out starts at $107,000 a year and you can no longer contribute with an annual income of $122,000.

There are also limits to how much you can contribute to a Roth IRA. You are limited to contributing $5,000 a year in 2011. (Amounts can go up, since the contribution limits are adjusted regularly to reflect inflation.) If you are 50 or older, you can contribute an extra $1,000 a year to your Roth IRA. This is known as a “catch up” contribution.

It is worth noting that getting a Roth IRA doesn’t preclude you from investing in a 401k. Indeed, it might be wise to take advantage of your company’s 401k plan, up to the maximum company match, and then invest in a Roth IRA.

Is a Roth IRA Right for You?

Basically, the answer to this questions depends on your financial situation. You can consult with a certified financial professional to get some better insight into what might work best for you. Generally, though, it is thought that a Roth account works best for those who expect to be in a higher tax bracket later, or who expect taxes to go up. Paying taxes now means that you pay less, and you won’t have to pay income taxes at a time when they might have gone up.