What Kinds of Investments are Roth IRAs?

Roth Individual Retirement Accounts are not investments at all. They are tax-advantaged accounts with rules laid out and enforced by the Internal Revenue Service. You are allowed to contribute a certain amount of cash to a Roth IRA annually, which you can use to purchase assets like stocks and CDs, as well as real estate and even gold. Qualified withdrawals from Roth IRAs are tax-free.

Function

The U.S. Congress passed Roth IRA legislation to help working Americans save for retirement. As of 2011, you are allowed to contribute up to $5,000 to a Roth IRA if you are under 50 years old, and up to $6,000 if you are 50 or older. Your contributions are taxed, but assets you purchase with your account are allowed to accumulate tax-free earnings. Beginning the year you turn 59 1/2, withdrawals, or distributions, from your Roth IRA are tax-free.

Roth IRA Custodians

You must establish a Roth IRA with an IRS-approved custodian. There are many different types of financial institutions that act as IRA custodians, including banks, credit unions, mutual funds, both full service and discount financial firms and insurance companies. The custodian you choose dictates the type of assets you can purchase with your account. For instance, a brokerage firm allows you to purchase stocks and bonds, while banks and credit unions might offer CDs and money market accounts.

Considerations

Most people choose to invest their Roth IRAs in traditional financial products, like stocks and CDs. However, you are by no means limited to these types of assets. The only things you are not allowed to purchase in your IRA are life insurance and collectibles, such as art, wine and classic cars. If you want to make money for retirement by investing in a business or renting properties, you can open an account with a self-directed IRA custodian. This gives you the freedom pursue whatever investment strategy you see fit.

Roth IRA Transfers

If you opened a Roth IRA with one custodian but then decide you want to invest your money elsewhere, you can make a tax- and penalty-free transfer to a new custodian. You can make a trustee-to-trustee transfer, in which you have your old custodian directly send cash or securities certificates to a new account. Or, you can make a rollover, in which you withdraw the money yourself and redeposit it in your new account within 60 days. The rollover method involves a 20-percent federal withholding that you must make-up when depositing the funds into your new account, but you get that money back at tax time.

Distributions

Distributions from a Roth IRA are tax-free as long as you wait until you are 59 1/2 to make withdrawals. Otherwise, earnings your assets receive -- as opposed to your contributions -- may be subject to income taxes and a 10-percent early withdrawal penalty. There are exceptions: you can take up to $10,000 from your Roth IRA without tax or penalty to pay for your first home, for example. You can also avoid the 10-percent penalty if you use a withdrawal to pay for qualifying education expenses, among other things.

References

• IRS.gov: Publication 590; What Is a Roth IRA?
• IRS.gov: Publication 590; How Much Can Be Contributed?
• IRS.gov: Publication 590; Are Distributions Taxable?
• IRS.gov: Publication 590; Prohibited Transactions
• IRS.gov: Publication 590; How Can a Traditional IRA Be Opened?
• IRS.gov: Publication 590; Can You Move Amounts Into a Roth IRA?