Investment Tips: What Is A Roth Ira

A Roth IRA provides a lot of advantages for the investor. Find out if this account is right for you.

It's a fact - Americans are living longer. The percentage of people living in America beyond the retirement age has increased dramatically over the past decade, and is only projected to get bigger as the baby-boomer generation winds down their working careers. With the recent questions surrounding the future of Social Security, retirement planning has suddenly become a much more important part of everybody's financial lives. For many people, retirement planning begins with a first step - opening an individual retirement account, also known as an IRA. If you are considering opening one of these accounts, you may want to consider opening a Roth IRA, which has several important features that distinguish itself from a traditional IRA.

The Roth IRA was created in 1997 when Congress passed the Taxpayers Relief Act and is designed to encourage savings by working Americans. Anybody can set up one of these accounts - there is no age limit on contributions - through their bank or an independent brokerage service. The beauty of a Roth IRA is that the earnings on any investment grow tax-free, and your distributions from the account go untaxed as well, meaning when you withdraw money during retirement age, the IRS will not tax you on this income. Furthermore, the Roth IRA allows you to withdraw any contributions you made (but not earnings) at any time, penalty and tax-free.

Do you qualify for a Roth IRA? For most Americans, the answer is yes, but it depends on your tax filing status and your income. Currently, single taxpayers can contribute the maximum amount allowable into their Roth IRA if their adjusted gross income (AGI) is less than $95,000. If you make more than that, up to $110,000, you can still contribute, but at a reduced maximum. If your AGI is over $110,000, you do not qualify for a Roth IRA. For married taxpayers filing jointly, the limits are $150,000 for maximum contributions, and $160,000 for reduced contributions. Anything over that disqualifies you. If you are married but file separate returns, you currently do not qualify for a Roth IRA.

There are caps on how much one can contribute to the account. For the tax year 2004, the maximum contribution is $3,000 (or 100% of your income, if it is less than this amount). For the tax years 2005-2007, the maximum is increased to $4,000; for 2008 it is raised to $5,000, and for every year after that the cap is raised by $500. A special provision has been added for older savers - known as a "catch-up contribution" - currently an extra $500 is allowed into the account if you are fifty years of age or over, though this is slated to go up to $1000 in 2006.

One limitation to the Roth IRA is that your contributions are not tax-deductible, as they are with a traditional IRA. This means that although this income is not available for you to use for many years, you still must pay income tax on it this year. However, considering the benefits of tax-free earnings in an investment account, it seems a small price to pay for most investors, especially if you expect to be in a higher tax bracket come retirement age.

In addition, there is a possibility that your contribution to any IRA can qualify you for a Retirement Savings Contribution credit. If your adjusted gross income falls within certain IRS guidelines you may be able to take up to 50% of your contributions into an IRA as a tax credit (this goes for both Roth and traditional IRA's). This is far better than a deduction, as it counts as taxes paid, rather than just reducing how much income you have to pay taxes on.

As mentioned earlier, most distributions from a Roth IRA are tax-free, if they qualify. In order to qualify, the distribution must be made after you are 59 and a half years old, and the contribution was made at least five years earlier. There are some exceptions - up to $10,000 dollars can be withdrawn for a first-time home purchase, and in the event of death or disability distributions also qualify. In most other cases you will be taxed on any distributions made, and may possibly face tax penalties as well. Certain distributions, although taxed, will not face this penalty - if you find that you are considering early distributions of your Roth IRA, and have any questions about your particular case, it is best to talk with a tax professional or the IRS about potential penalties and taxes you will have to pay.

Retirement can be a frightening prospect, but with a little planning it can be fruitful and secure. An IRA is one of the best ways of preparing for retirement, and the Roth IRA has many advantages for a lot of Americans. Whether you choose to open a Roth IRA or some other sort of investment account, the important thing is to start today.

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