What is a Roth IRA?
Roth IRA
A Roth IRA is an Individual Retirement Account that provides you with tax-free growth on your investment. The account is named after its chief sponsor in the US legislation, Senator William Roth. A Roth IRA differs in several significant ways from other IRAs, which can lead to some advantages and disadvantages. Overall, a Roth IRA is a significantly better way for you to save for your retirement.
The Roth is a tax-free retirement account; so no taxes are paid on any the interest, dividends, or gains -- ever. So the money you contribute to your retirement account accumulates interest, and you don’t have to pay taxes on the any of the money you make! However, unlike a traditional IRA, a Roth does not qualify as a tax deduction in the year you make the contribution.
So, the question is, do you want to cut your tax bill now or in retirement? All kinds of calculators can theoretically indicate which account will provide more in retirement. The conventional wisdom is that if your tax bracket now is higher than the tax bracket you will be in retirement, a deductible account might be the better bet.
Advantages
- Earnings made through the investment of funds into the Roth IRA completely escape taxation.
- At any time, the IRA owner may withdraw up to the total of their contributions.
- If there is money in the IRA due to conversion from a Traditional IRA, the IRA owner may withdraw up to the total of the converted amount.
- Earnings withdrawals become automatically qualified in the tax year the participant reaches age 59.5 or becomes disabled.
- Up to $10,000 in earnings withdrawals are considered qualified if the money is used to acquire a primary residence. This house must be acquired by the IRA owner, their spouse, or their lineal ancestors and descendants.
- There is a tax advantage to making contributions to a Roth IRA over a Traditional IRA or similar vehicle. While there is no tax deduction in the current year, money going into the IRA is taxed at the lower current rate, and will not be taxed at the higher future rate when it comes out of the IRA. Therefore, the Roth IRA offers a specific advantage where a person will retire in a higher tax bracket than that used during his or her pre-retirement years.
- One of greatest advantage of the Roth IRA is its lack of forced distributions based on age. All other tax-deferred retirement plans require withdrawals to begin at age 70½ (more precisely, by April 1 of the calendar year after age 70½ is reached), and impose an annual minimum distribution once withdrawals begin at any age beyond 59½. The Roth IRA is completely free of these mandates.
Disadvantages
- The main disadvantage of a Roth IRA (when compared to a traditional IRA) is that contributions are not tax-deductible when they are contributed to the account.
- There are heavy penalties for early withdrawals of earnings. An unqualified withdrawal of earnings will result in federal income tax plus a ten-percent penalty on the amount.
As with all IRAs, there are restrictions on whether and how much you can contribute based on your income level and filing status. If you are eligible in a given year then you have until the following April 15 to make a contribution.
When you look at the differences between a Roth IRA and other retirement planning programs, it becomes clear that the Roth provides substantial wealth building advantages. Sign up below to learn about the IRA business system, which gives you checkbook control over your IRA and provides a legal way to make the investments you want and take full control of your retirement plan!
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