Would you like your account to make as much money as possible? And have it be totally tax free later on when you need it? Well then you just might like a Roth IRA. Created as part of the 1997 Taxpayer’s Relief Act, and named after former Senator William Roth, the Roth IRA offers a unique planning benefit.
How Does the Roth Work?
Under the rules, one can contribute up to 100% of pay, or $5,500 annually. Whichever is less. The Roth IRA has the same limits as the traditional IRA. Furthermore, any earnings/growth from the account will grow tax deferred (no tax each year on earnings) and if withdrawn after 59 ½ , can be taken out tax-FREE!
There are some provisions which allow earlier withdrawal of Roth money for
first time homebuyers or education expenses for example. However, if this is done, earnings on the account that are withdrawn will still be taxed. One little-known feature though is that contributions to a Roth IRA can be withdrawn at any time – it’s the earnings that are restricted. Why?
Roth contributions go in after tax – one does not take a deduction for contributions to a Roth; therefore, since it’s after tax money, taking it out does not result in a taxable situation. Here’s an example:
- I contribute $5,000 to my Roth IRA.
- After one year, the account grows to $5,500.
- I can withdraw $5,000 without penalty or tax but if I withdraw $5,500, I will pay penalties and taxes on the $500 earnings (unless the withdrawal meets the provisions for penalty free withdrawals, such as first time home-buying – then the penalty, but not the tax will be waived).
Is the Roth for You?
Should you consider a Roth? Calculations on expected future tax rates, needs, and cash flow should be incorporated into a proper comparison of pros and cons. A competent advisor should be able to handle this task for you, or you could do it yourself. For the full scoop from the IRS on everything about both Roth and Traditional IRA’s, see Publication 590 (a detailed read).
If you’d like to learn more about Roth IRA options, use our question and contact form below and to read more about IRA’s, see our other articles including:
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