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Roth IRA 101

Updated on February 27, 2012

What is an IRA?

IRA stands for Individual Retirement Account, and is really just a label placed on an account that allows you to save for retirement. The government provides for special tax incentives on the money that you’re willing to save under the label “IRA”.

Roth IRA 101

Funding: Contributions to a Roth IRA are made with “after-tax” dollars. Simply put, you fund a Roth IRA using your paycheck or bank savings/checking account.

Funding Limits: Unfortunately, not everyone is eligible to contribute to a Roth IRA. The below table lists the funding limits for the year 2012.

Filing Status
Income
Contribution Limit
Single, or Married filing separately
$110,000 or less
$5,000*
 
$110,000 to $125,000
phase-out range
 
$125,000 or more
not eligible to contribute
Married, filing jointly
$173,000 or less
$5,000*
 
$173,000 to $183,000
phase-out range
 
$183,000 or more
not eligible to contribute

* if you are age 50 or older, you can contribute $6000

Withdrawals:

1) Contributions can be withdrawn at any time, tax-free, as long as the Roth IRA has been open for a minimum of 5 years. For example, if you contribute $5,000 and it grows to $8,000 in 7 years, you can withdraw your original $5,000 tax-free, and penalty-free.

2) Earnings/gains on contributions can be withdrawn tax-free after age 59 ½ . Prior to age 59 ½, earnings/gains are subject to a 10% premature withdrawal penalty. This penalty can be avoided if the withdrawn funds are used for certain qualifying reasons: (e.g. higher education expenses, first-time home purchase, disability, medical expenses)

Advantages:

1) Contributions can be withdrawn tax-free, and penalty-free (see Withdrawals #1 above). This is not the case with contributions to a Traditional IRA.

2) Withdrawals after 59 ½ are tax-free (unlike a Traditional IRA, where withdrawals are taxed as income).

3) Roth IRAs are not subject to Minimum Required Distributions. Traditional IRAs require distributions after 70 ½, per IRS rule.

Disadvantages:

1) Contributions are not tax-deductible, like they typically are with a Traditional IRA.

2) Tax-laws are subject to Congressional change, and while the benefits are applicable now, they may be different in the future.

Summary

In general, a Roth IRA is a VERY valuable retirement savings vehicle. Because you can access your contributions after your Roth has been opened for 5 years, and can still enjoy tax-free withdrawals after age 59 ½, it is one of the most flexible ways to save for your future.

This hub is intended to cover the basics of a Roth IRA. There are some not-so-common features of Roth IRAs that may be applicable to your situation, so it’s always recommended to consult your financial advisor. Or feel free to post questions in the comments section, and I’ll be happy to answer.

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