How to Use a Roth IRA for Tax Planning in Retirement

By eHow Personal Finance Editor

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Properly planning for retirement is one of the most financially important processes a person can undertake. An essential tool in this proper planning is the Roth IRA. The Roth individual retirement account allows the proceeds from the account to bypass government taxing provided the person follow a few rules.

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Instructions

Difficulty: Moderately Easy

Step1

Understand the contribution limitations for a Roth IRA. The Roth IRA limits the amount of annual contributions a person can make to the account. For the 2008 tax year, the limit is $5000. In addition, you must earn income to open a Roth IRA. Therefore, if you live at home and receive support from your parents, you cannot open a Roth IRA. Additionally there are upper income limits, above which you may not contribute fully or at all to a Roth IRA.

Step2

Reduce Roth IRA contributions, as you get closer to retirement. The main benefit of a Roth IRA is that the proceeds bypass taxing when the money is withdrawn in retirement. The drawback of the Roth IRA is that the contribution is not tax deductible like a tradition IRA. Therefore, as a person nears retirement it is better to invest in the traditional IRA and not the Roth IRA.

Step3

Contribute the maximum amount every year until a you reach approximately 8 to 10 years before your target retirement age. The Roth IRA, especially for younger people, is the best retirement vehicle and should be number one their list before unmatched company sponsored 401k retirement plans. Make the Roth IRA contributions a priority.

Step4

Withdraw money only if necessary but realize that is an option. If the Roth IRA is open for at least five years a person can withdraw their contributions tax-free. This does not apply to earnings however; the earnings withdrawn incur a tax penalty of the person's tax bracket rate plus ten percent.

Step5

Realize that the Roth IRA proceeds can't be withdrawn without penalty until the person is fifty-nine and half years old. The penalty for withdrawing earnings early is a person's tax rate plus 10 percent.