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14 May

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What is a Roth IRA?

May 14, 2014 | By |

Free Tax Shopping BagRoth IRA’a are a form of Individual Retirement Account that gives you tax-free income in retirement. While there is no up-front tax break associated with Roth IRA’s, the money you take out during retirement is tax-free. Roth IRA’s have been around since 1997 and are a valuable financial tool for retirement planning.

History of the Roth IRA

The first Roth-like IRA was proposed in 1995. It was vetoed twice and never came to fruition. With the passage of the Taxpayer Relief Act of 1997 Roth’s became law and the first contributions to the plan were allowed in 1998.

The new plan allowed after-tax contributions that would grow until contributors could be withdrawn tax-free. The plan also came with two other benefits. You could convert a Traditional IRA to a Roth IRA and the plan used the current year’s income to determine eligibility of the contribution and conversion.

Eligibility

There are income requirements to determine if you quality for a Roth IRA. Single filers with a modified adjusted gross income (MAGI) of $112,000 or less can contribute up to $5,500 in the plan. Married couples filing jointly can each contribute the same amount on income of $178,000 or less. At greater amounts of income, in both categories, the benefit begins to phase out until you eventually become ineligible for the Roth IRA.

Couples filing separately will find it very difficult to contribute anything at all to the Roth IRA. The income limits for these people begin at $0 but phase out completely at $10,000.

More Benefits

There are other benefits to the Roth that may influence your decision to open one:

Flexibility: Contributions can be withdrawn at any time without penalty or interest with a few exceptions. Generally you must hold the Roth for a minimum of five years and be 59 1/2 to withdraw growth without taxes and penalties. Some of the exceptions are: death or disability of the contributor, and first home purchases.

No Requirement Minimum Distributions (RMD’s): Unlike Traditional IRA’s, RMD’s in a Roth IRA are not mandatory. Your money can continue to grow and be passed on to your heirs. The heirs pay no income tax on the money but they will have to take distributions during their lives.

Savings: If you work and contribute to an employer plan such as a 401(k) or 403(b), you can still contribute to a Roth IRA. As long as you stay under the set income limits you can continue to contribute money.
Contribution deadlines

The date to contribute money to the Roth for the prior year is the April 15th deadline for your income taxes. However, if you file an extension on your tax return you can’t delay your Roth contribution until then. This means if you are getting a large tax refund, you can contribute some of that money into a Roth IRA for the previous year!

Final Thoughts

A Roth IRA is a valuable tool when thinking about retirement. It especially makes sense if you think your tax rate in retirement will be greater than your current tax rate. They also make sense for younger workers while their income is lower. The initial tax deduction won’t be missed and your money will grow tax free for decades. A Roth can also be used to lower your tax bite in retirement, or if you want to leave money to your heirs tax free.

Whatever your reason, a Roth IRA is a financial vehicle that should be looked into for your retirement planning. As with any financial planning, enlisting the services of a competent financial planner will give you peace of mind and help you to make better and more informed decisions.