When it comes to saving for your retirement, it does get much better than the Roth IRA. Created as part of the Taxpayer Relief Act of 1997, Roth IRAs allow contributions to grow tax free forever. There are, however, a few Roth IRA basics that all investors should know before deciding whether or not this type of account is right for them.
Roth IRA Basics
Contributions made to a Roth IRA are made with after tax dollars. When investing in a traditional IRA, tax payers can claim a tax deduction for amounts contributed. With a Roth IRA, however, contributions are not tax deductible. Instead, these funds are free to grow tax free forever. While this may not be a big deal for those individuals in the higher tax brackets, it can make a massive difference for with the lower to medium annual incomes.
Of course, since this type of tax treatment can be so powerful, the government has placed limits on the amount of money any individual can contribute within any given tax year. Current Roth IRA contribution limits are $5,000 per individual per year ($6,000 for those people older than 50); which is significantly lower than the maximum contribution limits allowed in a traditional 401k plan. If you need to withdraw any of your earnings before reaching the age of 59 ½, a 10% penalty will be assessed.
Additionally, there are a number of Roth IRA qualifications that need to be satisfied in order to be able to fully participate. Perhaps the most important thing to note is that those individuals, and families, that earn more than a certain amount cannot invest in a Roth IRA ($107,000 for single individuals and $169,000 for married people filing jointly).
One important aspect when investing in a Roth IRA that is often overlooked is the fact that you can pass these funds to your heirs tax-free when you die. It is important, however, to have the account set up properly to ensure that there are no estate or probate issues that arise. When it comes to completely understanding Roth IRA basics it is always a good idea to consult with a certified financial planner.