Let's Consider Roth IRAs
A Roth IRA is a tax-exempt personal retirement savings plan. It offers no tax deductions on contributed funds. Contributions to a Roth IRA are deposited tax-free and remain so even when they are withdrawn. All withdrawals from a Roth IRA are tax-exempt as long as the owner is at least age 59 ½ and the Roth IRA has been in his or her name for at least five years.
Who Is Eligible?
The Roth IRA was established with the retirement savings needs of the average American taxpayer in mind. To ensure that the Roth IRA tax exemptions are available only for their intended use, participation in the Roth IRA is restricted by income level.
The income restrictions are subject to yearly changes made by the IRS and are based on tax filing status. For 2008 and 2009, those income restrictions can be found in Publication 590, available in PDF format from the IRS free of charge.
How Does It Work?
Contributions made to a Roth IRA do not affect the owner's AGI, meaning all taxes are paid up front and in full. After the contribution is made, it will accumulate interest tax-free until withdrawal.
How much can be contributed?
Like Traditional IRAs, contributions to the Roth IRA are restricted by age and income level, with certain exceptional circumstances adjusting the final contribution amount. This means that the maximum contribution for a Roth IRA will vary from owner to owner.
For 2008, IRS Publication 590 set the yearly Roth IRA contribution limit at $5,000 or the value of the owner's taxable income for the year, whichever is less.
If the owner of the Roth IRA was 50 or older before 2009, the yearly contribution limit increases to $6,000. This benefit is generally referred to as a "catch-up" contribution.
Is there an age limit?
The owner of a Roth IRA can contribute to the fund and compound interest for as long as he or she lives, or longer. There is no age limit on a Roth IRA that mandates when contributions can or can't be made or when funds must be withdrawn. If beneficiaries are named for the Roth IRA, the heirs to the original owner can inherit the account and choose to withdraw funds or to make contributions of their own.
Like the Traditional IRA, the Roth IRA owner must be of age 59 ½ to begin penalty-free withdrawals. Unlike Traditional IRAs, though, Roth IRAs must be at least 5 years old before these withdrawals can be made. However, there are a few exceptions to this rule:
- If the owner is buying his or her first home, a limit is set for a penalty-free withdrawal of $10,000 from a Roth IRA.
- If the owner becomes disabled, the penalty is also lifted. Otherwise, withdrawals made before the 59 ½ age limit are subject to a 10% penalty.
Is the Roth IRA right for you?
If the investor qualifies for a Roth IRA, they will find it to be a great investment strategy. Roth IRAs offer a number of advantages, including:
- Inheritance Possibilities. A Roth IRA is a great way to boost your own retirement savings or to establish a generous inheritance for your children.
- Tax-Free Distribution. Since the funds you contribute to your Roth IRA are taxed before they enter the account, your eventual withdrawals will be tax-free.
- Penalty-Free Withdrawals. Taking advantage of the $10,000 first-home allowance is a great boost for young investors and a great incentive to start saving early.
- Additional Savings. If you already have a savings plan at work, the Roth IRA is a flexible option for an extra cash cushion.
