What is a Roth IRA?

April 12th, 2009 by David Leave a reply »

The Roth IRA was created by the Taxpayer Relief Act of 1997 and it was implemented on January 1st 1998. A Roth IRA is an individual retirement arrangement that allows tax free growth. Roth IRAs greatly differ from traditional IRAs.

One of the most obvious benefits of having a Roth IRA account is that all earnings are tax free when you or your beneficiary withdrawals them. One of the other benefits is that you can avoid the early distribution penalty on some withdrawals, like buying a house for the first time (after you had your Roth IRA account for at least 5 years).

Roth IRA Pros

  • Since you have already paid taxes on direct contributions, they can be withdrawn at any time tax and penalty free.
  • You can use up to $10,000 from your Roth IRA tax and penalty free if the money is used to purchase a primary residence. The property must be purchased either by the Roth IRA holder, their spouse or their lineal descendants. The Roth IRA must have been established for at least 5 years, for instance if you opened your Roth IRA in 2009, you will be able to use up $10,000 tax and penalty free in January 1st, 2014.
  • Money from a traditional IRA – Roth IRA conversion may be withdrawn without penalty. A period of 5 years must have passed on the converted funds.
  • With a Roth IRA you are not obligated to make distributions based on your age, if you don’t need the money, you can leave it for your descendants.

Roth IRA Cons

  • Contributions to your Roth IRA are not tax deductible, in the contrary, traditional IRA accounts are tax deductible.
  • Roth IRA eligibility is limited based on income.
  • Tax benefits may not be realized unless one lives to fully withdrawal the contributions.
  • The rules that allow you to withdrawal contributions tax free may be changed by the congress. The Roth IRA owner has to wait 5 years to take advantage of the tax free benefit, so he has to take the risk that the law may be changed during that time.

Eligibility

As previously mentioned, Roth IRA eligibility is based on income. A tax payer can contribute the maximum amount ($5,000 or $6,000 if age 50 or older) if their MAGI (Modified Adjusted Gross Income) is less than:

  • $101,000 for single individuals, head of household or for individuals who are married but are filing separately (and did not live with their spouse during the year).
  • $159,000 for those married filing together.

You can find more information by reading the Publication 590 (2008) from the IRS.

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