Why Should I Open Up a Roth IRA?
In 1997, the federal government introduced Roth individual retirement accounts (IRAs) with the passage of the Taxpayer Relief Act. These accounts offer a different tax incentive than the traditional IRAs, which had been around since 1974. You can take advantage of several benefits by opening a Roth IRA for yourself.
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Tax-Free Distributions
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Roth IRAs offer after-tax savings, which means your qualified distributions (withdrawals) come out tax-free. This applies to both the principal and returns in your Roth IRA. This tax advantage gives the biggest benefit to people who expect to pay a higher income tax rate at retirement than at the time they make the contribution. That is because you cannot deduct Roth IRA contributions from your income taxes. For example, if you are paying a 15 percent tax rate today and expect to fall in the 25 percent tax rate at retirement, you benefit more from a Roth IRA than a tax-deferred IRA.
Tax-Sheltered Growth
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Roth IRAs also offer tax-sheltered growth, which means that any returns on the principal contributed to the Roth IRA do not count as taxable income as long as the money remains in the account. For example, if your principal yields $2,000 in returns in a taxable account and you fall in the 20 percent tax bracket, you would have to pay $400 in income taxes. However, if you have those same returns in a Roth IRA, you do not have to pay any income taxes on the returns.
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Early Start
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The sooner you open a Roth IRA and make a contribution, the sooner you will meet the five tax-year requirement that must be satisfied before you can start taking qualified withdrawals. This requirement is in addition to you being at least 59 1/2 years old. Qualified withdrawals can also be made by people younger than 59 1/2 if they are permanently disabled or are taking up to $10,000 as a first-time home buyer. In addition, the longer you keep the money in your Roth IRA, the longer you can take advantage of the tax-sheltered growth offered by Roth IRAs.
Retirement Savings Credit
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The Retirement Savings Credit is an income tax credit rather than a tax deduction only available to people who have a lower modified adjusted gross income (MAGI) than the annual limit. These limits change annually to reflect inflation. For example, for the 2010 tax year you cannot claim the credit if you are head of household and have a modified adjusted gross income of more than $41,625. The credit's value equals a percentage of your contribution, between 10 and 50 percent, depending on your income.
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