Roth IRA Explained

Roth IRAs enable working individuals to save for their retirement years.

Named after Senator William Roth, Roth IRAs were introduced as retirement savings accounts in 1998. When compared to traditional IRAs, Roth IRAs provide saving advantages including tax-free rather than tax-deferred earnings and few withdrawal regulations. Similar to traditional IRAs, the Internal Revenue Service establishes contribution limits for Roth IRAs and adjusts them when increases in the cost of living warrant change. The IRS also establishes earning thresholds, which prevent certain people from contributing to Roth IRAs based on their incomes.

Eligibility

A Roth IRA account may be opened by an individual who records earned income on his federal income tax return regardless of the individual's age. Individuals contributing to Roth IRAs do not deduct the amount of their investments from their taxable income.

Contribution Limits

In 2011, a working individual may contribute the lesser of 100 percent of his earned income or $5,000 to a Roth IRA. If the individual has reached the age of 50, he may contribute an additional $1,000 in accordance with the IRS catch-up provision.

Depending on an individual's adjusted gross income (AGI) and tax filing status, the IRS may reduce or eliminate the person's ability to contribute to a Roth IRA. An individual filing taxes as a head of household or single person may contribute $5,000 if his AGI falls below $105,000. With an AGI between $105,000 and $120,000, the IRS incrementally reduces the amount an individual may contribute to a Roth and eliminates permissible contributions altogether if a person's AGI exceeds $120,000.

An individual filing a joint tax return may contribute $5,000 if his tax return records an AGI below $167,000. The IRS reduces the amount individuals may contribute to a Roth if their adjusted gross incomes fall between $167,000 and $177,000. An individual may not make a contribution to a Roth if the AGI reflected on his joint tax return exceeds $177,000.

Withdrawals

Unlike traditional IRAs, withdrawals from Roth IRAs are tax-free. If a Roth IRA account holder has attained the minimum age of 59 ½ and has owned his Roth IRA for at least five years, withdrawals from the account will not be taxed. Roth IRAs do not have minimum withdrawal amounts regardless of the account owner's age.

The Internal Revenue Service permits withdrawals including earned interest before an account holder turns 59 ½ without penalty under certain circumstances. If an individual withdraws money early because of death, disability or to fund the purchase of his first home, no taxes will be levied against the amount withdrawn.

An individual may access the amount he invested in his Roth IRA at any age and for any reason without penalty.

Conversion

Individuals who own traditional IRAs may convert their accounts to Roth IRAs but must pay income taxes on their account balances. The IRS used to grant this conversion privilege exclusively to those with adjusted gross incomes of less than $100,000. In 2011, an individual may convert his traditional IRA to a Roth IRA regardless of his earned income.

References

• IRS.gov: Internal Revenue Service: Publication 590 Individual Retirement Arrangements (IRAs)
• Bankrate.com; What Are the Roth IRA Rules?; Kay Bell; March, 2011
• Greene IRA Success: IRA Income Limits; Alyssa Holden; July, 2010
• RothIRA.com: The Roth IRA; Barry C. Picker, CPA/PFS, CFP
• Lange Financial Group: Roth: Four Little Letters Leading to Long-Term Financial Security; James Lange
• Moneycentral.msn.com: Haven't Converted to a Roth IRA? Good; Jeff Schnepper; December, 2010