What Is a Roth IRA?

Roth IRAs are tax-favored financial vehicles that enable investors to save money for retirement. They differ from traditional IRAs in that taxpayers cannot deduct contributions made to a Roth. However, qualified Roth IRA distributions in retirement are free of federal income tax and aren’t included in a taxpayer’s gross income. That can be advantageous, especially if the account owner is in a higher tax bracket in retirement or taxes are higher in the future.

A Roth IRA is subject to the same contribution limits as a traditional IRA ($5,000 in 2010). Special “catch-up” contributions enable those nearing retirement (age 50 and older) to save at an accelerated rate by contributing $1,000 more than the regular annual limits.

Another way in which Roth IRAs can be advantageous is that investors can contribute to a Roth after age 70½ as long as they have earned income, and they don’t have to begin taking mandatory distributions due to age, as they do with traditional IRAs.

Roth IRA withdrawals of contributions (not earnings) can be made at any time and for any reason; they are tax-free and not subject to the 10% federal income tax penalty for early withdrawals.

In order to make a qualified tax-free and penalty free distribution of earnings, the account must have been in place for at least five tax years and you must be age 59½ or older. Otherwise, these withdrawals are subject to the 10 percent federal income tax penalty with certain exceptions which include death, disability, medical expenses in excess of 7.5 percent of adjusted gross income, higher education expenses, and to purchase a first home (up to a $10,000 lifetime cap).

However, these withdrawals would be subject to ordinary income tax.

To qualify for a tax-free and penalty-free withdrawal of earnings in retirement (after age 59½), a Roth IRA must have been in place for at least five tax years. 

Keep in mind that even though qualified Roth IRA distributions are free of federal income tax, they may be subject to state and/or local income taxes. Eligibility to contribute to a Roth IRA phases out for taxpayers with higher incomes.

If you’re looking for a retirement savings vehicle with some distinct tax advantages, the Roth IRA could be appropriate for you.

The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor.

  

This material was written and prepared by Emerald.
© 2010 Emerald

Calculators

Market Watch

Last Closing Prices

Ticker Name Percent Difference (when noted with %) otherwise Last Price Difference (where applicable)
Dow Jones Industrials 24,329.16 +0.49
Nasdaq Composite 6,840.08 +0.40

[ Markets | Charts | Quotes | Portfolio ]

Market data delayed per exchange rules.
All quotes are in US Eastern Time (EST).
Market data provided by ICE Data Services. ICE Limitations. Powered and implemented by FactSet. Legal Statement.