A Roth IRA can be a great way to save a significant sum for retirement, especially if you don't have an employer to set up a plan for you. However, there are limits to how much money you can contribute each year to a Roth IRA.
A Roth IRA allows a person to contribute post-tax dollars to an account to save for retirement. The money in the account grows tax-free. It can also be withdrawn tax-free, as long as the account holder is at least 59 1/2 years old. This provides an enormous tax savings. To prevent abuse, there are limits to the amount that can be contributed. There are also limits to the amount of income one can have in order to contribute.
For 2008, the maximum contribution to a Roth IRA is $5,000, and a contribution cannot be higher than the total amount of income earned. In other words, the money you contribute to a Roth IRA must come from earned income. If you earned less than $5,000, you can only contribute up to the amount you earned. Caveats: • If you are age 50 or older before 2009, you can contribute $6,000. • If your modified adjusted gross income is over $169,000 filing jointly (or $116,000 filing singly), you cannot contribute to a Roth IRA. • If your income is between $159,000 and $169,000 filing jointly (or between $101,000 and $116,000 filing singly), you can make a reduced contribution, depending on where you are in that range.
The Roth IRA is often confused with a traditional IRA. A traditional IRA has similar-sounding but lower limits. These limits do not determine whether you can contribute to a traditional IRA, but rather whether you can deduct your contribution. You can never deduct a contribution to a Roth IRA.
If your modified adjusted gross income is below the levels at which a deduction is allowed for a contribution to a traditional IRA, you should evaluate whether it is better for you to use a traditional or Roth IRA. Generally, the further you are from retirement, the better the Roth IRA is, and vice versa.
Usually all the dividends and interest paid on investments is taxable in the year it is paid. However, no taxes are paid on such income for investments inside a Roth IRA. Further, other retirement accounts like traditional IRAs and 401(k) plans are subject to ordinary income taxes when the money is withdrawn, even during retirement.