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What Is a Roth IRA – Benefits & Restrictions

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Planning your retirement is one of the most important decisions that you will ever make concerning your financial future. Many people have questions about the different types of retirement accounts available and which one is the right plan for them. Let’s take a look at one type of retirement account known as the Roth IRA. A Roth IRA is an individual retirement account which allows an individual to set aside a specified dollar amount of income after taxes. This tax-advantaged retirement account derives its name from United States Congressman William Victor Ross Jr., who was the legislative sponsor of the bill creating this plan.

A Roth IRA provides tax free growth of your money in lieu of getting a tax deduction. Think of a Roth IRA as an umbrella, and you can put almost anything that you want under it. A Roth IRA may be invested in stocks, bonds, mutual funds, certificates of deposits, and/or money market accounts. Individual retirement accounts can be set up at a bank, brokerage house or any financial institution.

Roth IRA Eligibility

Here are a few of the rules to be eligible to fully contribute to a Roth IRA:

  • If you are a single tax filer your modified adjusted gross income needs to be less than $105,000. Married tax filers need their income to be less than $167,000.
  • The maximum annual contribution is $5,000 per person. Married couples can contribute $10,000. If you are 50 or older you can contribute $6,000 per person annually due to a catch-up provision.
  • Your contributions can be withdrawn at any time and are not tax deductible because they are made in after tax dollars.

Roth IRA’s are an easy way of creating tax free income and growth for your retirement portfolio.  Let’s say you invested $5,000 annually over a 20 year period into a Roth IRA, and at the end of 20 years, your money grew to$500,000. You may have lost out on the tax deduction on the $100,000, but you do not have to pay any taxes on the $500,000 when you withdraw funds after age 59 and a half. This can add up to a substantial savings as your earnings increase.

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Roth IRA Benefits

  • Tax Free Growth. Earnings are not subject to income tax as long as you have held the account for at least 5 years, and you are at least 59 1/2.
  • Easy Withdrawal Process. Direct contributions can be withdrawn at any time, tax free.
  • Multiple Retirement Accounts. A Roth IRA can be set up even if you have another retirement plan.
  • No minimum withdrawal requirements. There are no required minimum distributions as in a traditional IRA or 401(k).
  • Inheritance. Assets can be passed onto beneficiaries after death.

Roth IRA Restrictions

  • No Tax Deductions. Contributions are not tax deductible as they are in Traditional IRA’s and 401(k)’s.
  • Income limits on participation. You may not be eligible to enroll in a Roth IRA if your income is higher than the income limits.
  • Early Withdrawal Fees. There is a 10% early withdrawal fee if you withdraw money before 59 1/2 without a qualified reason (education expenses, first time home purchase, disability, medical expenses, death, health insurance, etc).

Final Word

Opening a Roth IRA is a great way of taking control of your financial future and a smart move for anyone that is eligible to open one.  How many of you already have a Roth IRA? If so, are you happy that you opened one?

(photo credit: thelastminute)

Mark Riddix
Mark Riddix is the founder and president of an independent investment advisory firm that provides personalized investing and asset management consulting. Mark has written financial columns for Baltimore and Washington, D.C. area newspapers and is the author of the book, "Your Financial Playbook."

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