Does Roth IRA Build Interest?
The Roth IRA is a tax-qualified structure regulated by the Internal Revenue Service. As a structure, the Roth IRA itself isn't an investment vehicle, but it can hold any one or a combination of many options, including fixed-income investments, equities and real estate. Building earnings within the Roth is contingent on how your chosen investments perform.
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The Roth Structure
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The Roth IRA was established in 1997 by the Taxpayer Relief Act. The first contributions started Jan. 1, 1998, with a total of $2,000 in maximum annual contributions. Money put in gets no deduction against taxable income and is thus defined a post-tax dollars. These contributions will never be taxed again, however. Distributions are designed for tax-free income, but you must be at least 59 1/2 years of age and must have funded the Roth for at least five years to qualify. Early distributions of earnings are taxed as income and penalized 10 percent on the amount of the early earnings withdrawal. As of 2011, the Roth structure remains the same, but the contribution limit is $5,000 annually with an extra $1,000 allowed for Roth owners age 50 or older. Technically, you can put funds into a Roth IRA and hold them without any investment chosen, getting zero growth, though this would defeat the purpose of the structure.
Fixed-Income Choices
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Referring to "building interest" generally refers to the rate of return earned in fixed-income investments. There is more than one type of fixed-income investment allowed in Roth IRAs. A certificate of deposit (CD) is sold by banks, offers a rate of return for the CD term and is insured by the FDIC. A fixed annuity is similar to a CD, but it is insured by the offering insurance company and has longer terms, although it generally has a slightly higher rate of return than the bank investment. Bonds come with different returns reflective of the risk levels. Treasury bonds are more conservative, while corporate bonds have more risk involved. All these investments offer interest appreciation when purchased in the Roth.
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Variable-Rate Choices
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Equities are the standard for variable returns with retirement savings accounts such as Roth IRAs. Mutual funds are one common investment in which your money is pooled with other investors who have the same investment objectives. The fund manager buys stocks meeting those objectives and manages the fund for you. Individual stocks also are available to investors. Brokerage firms must be the custodian for these investments, and there are no guarantees on returns or principal protection. Real estate IRAs use specialty custodians. The IRS only allows investment real estate purchases in an IRA. You can lose IRA status and pay taxes on the amount considered distributed for violating IRS regulations.
Considerations
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Your Roth IRA gives you the ability for growth without concern for annual taxes or later income taxes. The younger you are, the more time you have to withstand fluctuations in equity performances. As you get closer to retirement, the goal becomes preservation of capital for income purposes, and that usually means focusing more on fixed-income investments. Investment advisers can help create an appropriate portfolio to reduce risk but maximize long-term growth.
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