Sponsored by Senator William Roth and established by the Taxpayer Relief Act of 1997, the Roth IRA has become one of the most popular individual retirement plans. Taxes are one of the biggest impediments to retirement investing, particularly at the beginning of a person's career path.
What are the advantages of a Roth IRA?
Since a great deal of money earned is lost in taxes and other contributions, it can be difficult to find any discretionary income left to invest. However, Roth IRAs make it extremely advantageous to do so, since future earnings will not be subject to taxes (assuming that the tax-payer will be in a higher tax bracket when time comes to retire). Maxing out these contributions as soon as possible often allows for a comfortable, worry-free retirement assuming certain conditions are met.
What are the contribution limits?
In 2014, for people aged 49 and below, up to $5,500 dollars per year can be contributed to a Roth IRA. When a person hits the age of 50, that figure increases to $6,500. This money must be used in an individual retirement plan, where the money is invested in securities and other financial products. This money can also be used to fund an annuity, which guarantees payments to the recipient at a certain level for a certain period of time, or for the remainder of their natural life. Higher income individuals may not be eligible for a Roth IRA, the maximum contribution rate allowed begins to be reduced at adjusted gross incomes over $114,000 and phases out completely at $129,000 for singles. The phased reduction in contributions allowed begins at incomes of $181,000 and ends at $191,000 for joint returns.
When can you make withdrawals?
After a 5-year "seasoning" period, contributions and earnings may be withdrawn at any time without a tax penalty. However, there is the added condition on earnings that the person must be at least 59 and a half years of age. Contributions are not subject to this stipulation and can be withdrawn at any time without penalty. This means that, so long as the investor is comfortable with paying taxes at the current rate, there is little risk with a Roth IRA approach. Distributions from a Roth IRA do not increase gross income since they are not subject to tax. This allows the retiree to maintain a lower tax bracket than they would if their retirement account was not funded by Roth contributions. This is due to traditional investments having their earnings subject to taxation and counted as revenue for tax purposes. Also, these funds do not add to the liability for estate taxes.
If a Roth IRA owner dies, the funds in that retirement plan are allowed to be converted to a spouse's Roth IRA with no penalty. Also, there is no age requirement to begin disbursement from a Roth IRA. If the investor does not need the money, they can continue to accumulate tax-free earnings and leave the account to their estate.
However, Roth IRA funds cannot be used as collateral for a loan. Also, these contributions are not a source of tax deduction, unlike contributions to a traditional retirement plan. Most importantly, investors who opt to utilize a Roth IRA are betting that their tax liability or the effective tax rate will go up. Basically, they are electing to pay taxes at the current rate. If investors overestimate their future tax liability, this is often a costly error.
