Overview of Roth IRAs

An individual retirement account (IRA) is another option to use when planning retirement. There are a few different IRAs including traditional and Roth. You can choose either or both depending on your financial situation and retirement goals.

What is A Roth IRA?

A Roth IRA is a retirement savings account held by a financial institution. It differs from a traditional IRA in the fact that a Roth IRA is funded with money after taxes were paid. Paying the taxes up-front allows tax-free growth and tax-free withdrawals as long as certain conditions are met.

A traditional IRA uses pre-tax dollars to fund the account and you must pay regular income tax when withdrawing the money. Since the Roth IRA uses after-tax dollars, you will not owe any income taxes on the contributions. Money in the Roth IRA account can continue to grow. The only penalty you will incur is if you withdrawal investment money before the age of 59.5 without a qualifying reason.

Money from contributions can be withdrawn at any time from a Roth IRA account without penalties. This is unlike a traditional IRA that will charge a 10% federal penalty on top of the income tax due for early withdrawals.

What Are The Benefits Of A Roth IRA?

There are benefits to funding a Roth IRA:

  • There are no 'equired minimum distributions' (RMD). Unlike traditional IRAs that require a certain amount to be withdrawn after age 70.5, Roth IRAs can remain untouched for years.
  • You can still contribute to a Roth IRA after age 70.5. Traditional IRAs stop contributions at age 70.5, however Roth IRAs continue to allow these contributions with tax-free growth.
  • Easy access to the money if needed. Roth IRAs allow for early withdrawals of contribution money for any reason with no penalties. If the contributions are the result of a rollover from a traditional IRA to a Roth IRA, then you must wait five years before withdrawing that money without penalties.

Am I Eligible For A Roth IRA?

Eligibility for a Roth IRA is based on income. CNN Money reports that you are eligible to contribute to a Roth IRA if you have taxable income and fall into any of these income guidelines:

  • If the modified adjusted gross income (AGI) is less than $167,000 if married filing jointly.
  • If the modified AGI is less than $105,000 if filing as single, head of household, or married filing separately and not living with the spouse (check with current tax laws regarding length of time).
  • If the modified AGI is less than $10,000 if filing married filing separately and you lived with your spouse.
Always check with your financial advisor for the latest income guidelines.

Are There Any Limits On Withdrawals?

Contributions can be withdrawn at anytime, however investments do incur a 10% penalty if withdrawn earlier than age 59.5. The IRS views withdrawals as money from contributions. When the funds from contributions have been depleted, then the IRS will view the remainder as investment money and penalize the amount withdrawn. Money rolled over from a traditional IRA will be considered before investments only if the mandatory five year period has ended.

Money from investments can be withdrawn before age 59.5 if there is a qualifying reason. These qualifying reasons include:

  • Needing funds to pay for college expenses. These expenses can be for you and your spouse, children, or even grandchildren.
  • Paying large medical bills that are over 7.5% of your AGI.
  • Needing funds due to a sudden disability.
  • Purchasing a home for the first time. The limit allowed is $10,000.

You should discuss the risks and benefits of withdrawing early using a qualifying reason with your financial advisor before moving forward. The longer you leave the money in the account for retirement the more time it has to grow. An advantage of contributing to a Roth IRA is no mandatory withdrawals. Leaving the money in the Roth IRA will allow it to grow tax-free which could be useful to your heirs.

Is It Better To Have A Traditional IRA Or Roth IRA?

Income can be a deciding factor when choosing between a traditional and a Roth IRA. The income guidelines drive the eligibility for Roth IRAs. Experts recommend diversifying investments as well as contributing to both taxed and tax-free retirement savings accounts.

By diversifying these accounts, you will not have to worry about what tax bracket you may be in by retirement age. This is especially true if you have a few decades to work before retirement. Choosing the best retirement savings account or a mix of accounts will be dependent on your financial circumstances, your current age, and your target retirement age.

How Do I Open A Roth IRA?

Financial coach Dave Ramsey recommends enlisting the help of an investment advisor. Brokerage firms, mutual fund companies, insurance companies, and banks can also open accounts for you and assist with the process.

The financial institution will need a copy of the same documentation required to open any other account. You will probably need to provide a valid picture identification card, social security number, banking information, and employer's information. A beneficiary will also be assigned in case of inheritance to the Roth IRA account. You may be asked to provide the beneficiary's information.

An initial deposit will be required and contributions cannot exceed the annual limit. Contributions can be made in monthly installments or lump sums depending on the financial institution. The total annual contribution limit in 2015 is $5,500 or $6,500 if age 50 or older.

Choosing to contribute to a Roth IRA may be in your best interest if you think you may need access to those funds before retirement. The flexibility a Roth IRA offers and tax-free growth are also considerations. Check with your financial advisor before opening a Roth IRA or any retirement savings accounts to see which ones are more profitable for you and your family.