What Is a Roth IRA?

1. What Is a Roth IRA?

An IRA (Individual Retirement Account) provides tax breaks for individuals who wish to set aside money for retirement. The Roth IRA, established in 1998, is unique. Unlike the traditional IRA, the Roth IRAs earnings are tax free. Withdrawals from a Roth IRA are tax free after age 59-1/2, if the account has been open for at least five years. The traditional IRAs contributions are originally tax deductible, but contributions and earnings are taxed when withdrawn. For those who need to direct and manage their own retirement investments, the Roth IRA can be an investment strategy with significant benefits. 

2. Who Can Contribute to a Roth IRA?

Generally, if you or your spouse has earned income, you can contribute to a Roth IRA. Unlike the traditional IRA (which disallows contributions after 70-1/2 years of age), there are no upper or lower age limits for contributing to a Roth IRA. You can contribute to a Roth IRA in addition to your employer’s 401(k) or 403(b) plan. The allowable size of your contribution to a Roth IRA is based upon your modified adjusted gross income (AGI). Above certain limits for modified AGI (depending on your tax filing status), the amount you can contribute to a Roth IRA is gradually phased out.

3. How Do I Contribute, and How Much Can I Contribute to a Roth IRA?

Investing in a Roth IRA is usually done through mutual funds or common stock, though other investment vehicles such as certificates of deposit are options for opening a Roth IRA. Contribution limits are determined by your Adjusted Gross Income (AGI) on your tax returns, and your age. For a particular tax year, contributions to an IRA may be made any time during that year or until April 15 of the next year.

4. What about Converting from Roth to Traditional IRA, or Traditional to Roth?

If you convert from a traditional IRA to a Roth IRA, you’ll pay taxes up front. However, you’ll be able to continue to contribute to your Roth after age 70-1/2, unlike the traditional IRA. You’re also not required to take a given amount per year from the Roth, unlike the traditional IRA. Your unique tax situation will determine whether conversion from traditional to Roth IRA is the best choice for you. 

5. When Can I Withdraw My Roth IRA funds?

Original contributions (not earnings) in your Roth IRA can be withdrawn at any time. Roth IRA earnings can be withdrawn if they meet the requirements of a qualified distribution, and the account has been open at least five years.

Some requirements include:
· Age 59-1/2 or older
· Disabled
· Distributions to be used toward qualifying medical, higher education, or expenses for a first home

Consult a tax advisor for detailed information on withdrawing Roth IRA funds.

6. What are Penalties for Withdrawal from a Roth IRA?

Most withdrawals of Roth IRA earnings, prior to age 59-1/2, will be penalized with an “early withdrawal penalty” of ten percent of the distribution. For a “non-qualified distribution,” these penalties are in addition to any tax imposed on the distribution. 

7. What’s the Difference between a Roth IRA and a Traditional IRA?

Traditional IRA contributions are tax deductible until withdrawn; Roth contributions are not. However, Roth IRA earnings are tax free, while traditional IRA earnings are taxed upon withdrawal. In many cases, the Roth IRA offers more flexibility for contributing and withdrawing funds. Your unique financial and tax situation will determine whether a Roth or Traditional IRA is most beneficial for you. 

8. How Do I Convert My Traditional IRA to a Roth IRA?

Conversion can happen at any time. You’ll pay taxes on the amount converted from a traditional IRA (since the original contribution to a traditional IRA is tax deductible), but no penalties. The choice to convert will depend upon your tax rate now versus your estimated tax rate in retirement, how long the Roth IRA will remain untapped, and how you will pay the taxes involved in the conversion. Consult your tax advisor.

9. Should I Contribute to My Roth IRA First or to My Employer 401(k) or 403(b) plan?

Generally, this will depend upon your tax situation and the nature of your employer’s 401(k) or 403(b) plan. If your employer offers to match the first five percent of your contributions to the plan, contribute at least five percent to take advantage of this “free money.” Beyond maximizing the benefit of an employee match, consider whether your 401(k) or 403(b) is pre-tax or post tax (such as the Roth 401K). Also consider that a Roth IRA may give you a broader choice of investment options than the options that your employer’s 401(k) or 403(b) plans offer.

10. Where Can I Learn More about Roth IRAs?

Here are a few of many resources that cover the Roth IRA:

· The IRS Guide to Roth IRAs
· A calculator for IRA conversion: http://moneycentral.msn.com/investor/calcs/n_roth/main.asp
· FDIC information about Roth IRAs:http://www.fdic.gov/deposit/deposits/deposit/faqs/faqs2.html