How to Understand a Roth IRA
Many Americans are investing their money in a Roth IRA (Individual Retirement Account) or are considering doing so. It's important that they understand this popular savings plan and how it differs from a Traditional IRA. Understanding the Roth IRA can have a significant impact on your financial planning for retirement.
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Instructions
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Consider your IRA withdrawal plans. Early withdrawals on the principal in your Roth IRA account are not usually subject to tax penalties, although withdrawals of any interest the money accrues will be taxed. On the flip side, withdrawals from a Traditional IRA will be penalized if you are under age 59½.
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2
Assess your current tax situation. While you won't be penalized for early withdrawals from a Roth IRA, your contributions to the account are not tax-deductible. By contrast, contributions to a Traditional IRA are tax-deductible but are subject to taxation upon withdrawal. You may withdraw your Roth IRA's principal and earnings totally tax-free upon reaching 59½.
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Confirm how much annual income you wish to invest in your IRA. You may not invest more than $5,000 in a Roth IRA during a year. If you have a Roth and a Traditional IRA, your combined annual contributions to both accounts may not exceed $5,000. If you are 50 or above, the yearly limit is $6,000.
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Determine if your annual income makes you eligible for a Roth IRA. Single individuals may not open a Roth IRA if they make more than $95,000 a year. Married couples may not open a Roth IRA if they make more than $150,000 a year.
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Decide how much diversification you want in your investments. Roth IRA funds may be used to purchase common stocks, mutual funds, bonds, certificates of deposit or even real estate.
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Tips & Warnings
Your tax situation will most likely determine whether you should invest in a Roth IRA. Some are dissuaded by the plan's rule against tax-deductible contributions, while others are drawn to the prospect of tax-free distributions at retirement. Simply put, if you follow all the rules and regulations for a Roth IRA, you will get your principal back 100% tax-free, plus earnings.
