How Does the Roth IRA Work?
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Roth IRA Tax Advantages
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The Roth IRA is a popular way to invest for retirement because of its generous tax advantages. Investments in a Roth IRA are allowed to grow tax free and are also tax free when distributions are taken in retirement. If your Roth IRA investments grow substantially, the tax savings can be tremendous.
Roth IRA Eligibility
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Only certain taxpayers are allowed to open Roth IRA accounts. They must not exceed income limits during the tax year when they open their Roth IRA. In 2009, a taxpayer filing as single could have a modified adjusted gross income no higher than $120,000. The limit for those with status married filing jointly is $176,000. Those with status married filing separately are not allowed to open Roth IRAs.
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Roth IRA Rollovers
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It is possible to rollover money from an employer sponsored 401k account or a Traditional IRA into a Roth IRA. However, taxes must be paid on the proceeds of these retirement accounts before the money can be deposited into a Roth IRA. This rollover can only occur during a tax year in which the taxpayer has a modified adjusted gross income of less than $100,000.
Contribution Funds
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Contributions to a Roth IRA can only be with money that was earned as taxable compensation. This is income earned from a job and not from investments. As a result, the maximum Roth IRA contribution can be no higher than a taxpayer's taxable compensation for that tax year. The Internal Revenue Service fines taxpayers 6% per year on non-taxable compensation deposited into a Roth IRA account until it is removed.
Annual Contributions
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Taxpayers are allowed to contribute more money to their Roth IRA accounts every tax year as long as they fall beneath the income limits. These amounts change from year to year. In 2009 it was $120,000 for single taxpayers, and $176,000 for married filing jointly taxpayers. Married filing separate taxpayers can not contribute to a Roth IRA.
Contribution Limits
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In both 2008 and 2009, eligible taxpayers are allowed to contribute a maximum of $5,000 of taxable compensation to their Roth IRA accounts. Eligible taxpayers older than 50 years olds are allowed to make contributions up to $6,000 per year. This is called a "catch-up contribution." These contribution limits change periodically, so check with the IRA for the latest numbers.
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