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Roth IRAs

A Roth IRA is a special type of Individual Retirement Account named for its original chief legislative sponsor, Senator William Roth of Delaware. First made available in 1998, Roth IRAs offer a few key advantages over other IRA options (such as Traditional IRAs) for those who qualify.

Roth IRA Basics

Roth IRAs are intended for use as retirement savings accounts; as such, limited contributions can be made to them throughout the tax year. Funds within a Roth IRA are held by a custodian (usually a bank or broker), and tax-free withdrawls can then be made from the account once the contributor reaches 59½ years old, as long as the account has been active for five years or more. Money contributed to a Roth IRA account must be derived from income resulting for work. Thus, only those who work for a living may contribute to a Roth IRA account.

Roth IRAs, like most types of IRAs, are flexible in terms of the investment vehicles that can be utilized within the account. Investors normally contribute to their Roth IRA in the form of securities, such as stocks or mutual funds, but other investments are also possible, such as CDs, notes, derivatives, and even real estate.

Roth IRA Advantages and Disadvantages

Roth IRAs are one of the best options available for many Americans saving for retirement. That’s because Roth IRAs…

  • Don’t incur any taxes on asset appreciation, such as dividends,
  • Offer the best tax protection when withdrawing money from the account, and
  • Have fewer withdrawal restrictions and requirements.

The only disadvantage to Roth IRAs (versus Traditional IRAs) is that contributions must come from taxable income. In most cases, however, this disadvantage is nullified when you retire and begin making withdrawals, which are tax-free in most cases.

Roth IRAs vs. Traditional IRAs

The most important difference between Roth IRAs and Traditional IRAs is the way invested money is taxed. Withdrawls from Roth IRAs are generally not taxed (as long as the withdrawal requirements are met), while Traditional IRA withdrawls are treated as taxable income.

Compare Traditional vs. Roth IRAs »

Roth IRA Contributions

Unlike Tradtional IRAs, contributions made to a Roth IRA are not tax-deductable. In most cases, though, the long-term savings realized during retirement (when withdrawls aren’t taxed) will be far more valuable that a short-term tax write-off.

The maximum amount of money a taxpayer can contribute to his or her Roth IRA each tax year is determined by their age and taxable compensation. For tax year 2013, taxpayers under the age of 50 could contribute $5,500 annually to their Roth IRA. Those 50 or older could contribute a maximum of $6,500.

Those contribution limits are expected to rise by $500 per year after 2013, depending upon the rate of inflation.

More detail on Roth IRA contribution limits »

Roth IRA Eligibility

Taxpayers must meet certain requirements in order to be considered eligible to contribute to a Roth IRA. These requirements are based on the Modified Adjusted Gross Income (MAGI) of the contributor(s), which includes all wages, tips, salaries, bonuses and professional fees. Those that earn below a certain threshold are eligible for the full contribution amount, while those that make more than the limit are either allowed partial contributions, or none at all. Here are the 2013 MAGI guidelines:

  • Single filers: Maximum contribution allowed if MAGI is below $112,000. Partial contributions allowed from $112,000 to $127,000, while taxpayers with a MAGI over $127,000 are not eligible to contribute at all.
  • Joint filers: Maximum contribution is allowed if combined MAGI is below $178,000. Partial contributions are allowed from $178,000 to $188,000. Over $188,000 are not eligible to contribute.
  • Married filing separately (as long as the couple lived together during any part of the year): $0 for full contribution, $0 to $10,000 for a partial contribution. Those with MAGI over $10,000 are not allowed to contribute.

More about Roth IRA Income Limits »

401k and 403b Exclusivity

Money you contribute to an employer’s 401k of 403b plan does not affect your ability to contribute to a Roth IRA fund. Thus, your contribution limits are the same, regardless of your other employer-sponsored retirement plans.

Opening a Roth IRA Account

You can open a Roth IRA account with nearly any major brokerage. Once opened, you may begin contributing to it, or you can roll over funds from other types of accounts (such as 401ks or Traditional IRAs). The funds you roll over into your Roth IRA do not affect your contribution limits for that tax year.

How to Open a Roth IRA Account »