Roth IRA Basics


What is an IRA?


An IRA is an Individual Retirement Account, you contribute money to this account up to your yearly maximum, and the money is allowed to grow free from taxes. Growing free from taxes allows a greater rate of return since you are not losing anything to capital gain taxes, short term gain taxes, or taxes on dividends and interest. You gain this tax deferred advantage because you agree to certain rules that go along with having this type of account. You set up the account yourself at a custodian. Not only are the accounts usually free, but you may be able to get incentives such as free trades or even cash. A lot of firms now provide a wide variety of ETFs that are free to trade.


What does the Roth part mean?


There are two basic options for an IRA, a Roth or a Traditional. By choosing a Roth IRA, you are putting money that you have already paid taxes on into the account instead of paying taxes on the money when you withdrawal it in retirement. This also means that you do not get a tax benefit for contributing like you may get with a Traditional IRA.


What are the income limits on a Roth IRA?


For 2016 you can contribute $5,500 if you are under 50 and $6,500 if you are older than 50. There are income restrictions on the account. If you are single you can contribute the maximum if your MAGI is less than $117,000. If you are married filing jointly you contribute the maximum if your MAGI is $184,000 or less. The amount you can contribute above those levels slowly phases out until your MAGI is more than $132,000 and $194,000 respectively. You can still get money into a Roth if your income is above those levels with a conversion. You must have earned income to be able to contribute to an IRA and can only contribute up to that amount if you made less than the maximum contribution for the year.


When can I contribute to my Roth IRA?


The deadline for making a contribution to your Roth IRA for a given tax year is typically April 15 of the following year.


How long do I have to wait before I can withdrawal my money?


You can actually withdrawal your money at any time, but it may be subject to income taxes and a 10% penalty. As long as the account has been open for more than 5 years, once you are over 59.5 years of age you can withdrawal the contributions and earnings with no taxes are penalties. If you are under age 59.5 and the account has been open for at least 5 years, you can withdrawal the contributions that you have made to the account. You may withdrawal earnings from the account after the 5 year rule if the money is used for things such as higher education expenses, up to $10,000 for the purchase of a first home, or high unreimbursed medical expenses.


Am I forced to withdrawal money at a certain age?


One of the great benefits of a Roth IRA is that they are not subject to RMDs. Let’s say you contribute $5,500 at the age of 25 and let that money grow untouched until you pass away at age 85. Your child inherits the Roth IRA and can choose the 5 year method which would give the Roth 65 years of tax deferred growth! If they choose the life expectancy method, the money can possibly grow tax deferred for even longer!


Why would I pay taxes on the money now, isn’t that a bad idea?


By paying taxes now you are actually able to put more money into the account since it is $5,500 post-tax dollars instead of pretax dollars. When you would withdrawal money in retirement, your Roth withdrawals would be smaller than withdrawals from a Traditional IRA while still maintaining the same after tax purchasing power. You also have to plan for what your tax rate will be in retirement, and if your current tax rate is lower, it is better to pay taxes now.

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