Retirement questions: what is a roth ira?

A Roth IRA is a retirement account that allows individuals to save for retirement on a tax-advantaged basis.

A Roth IRA is a retirement account that allows individuals to save for retirement on a tax-advantaged basis. Although contributions to a Roth IRA are not tax deductible, qualified withdrawals are tax-free. Unlike traditional IRAs, contributions can be made to Roth IRAs at any age, and there are no required minimum withdrawals after age 70 1/2. However, minimum distribution rules do apply to a beneficiary who has inherited a Roth IRA after the owner’s death.

In order to contribute to a Roth IRA, the contributor must have taxable compensation. Compensation can take the form of wages, salaries, tips, professional fees, bonuses, commissions, self-employment net income, and taxable alimony and separate maintenance payments. In addition, the contributor must have a Modified Adjusted Gross Income below certain specific amounts that vary based on tax filing status. Contributions for a tax year must be made before the due date of the tax return for that year.

Roth IRA contributions are capped at a specific amount for each tax year, or the contributor’s total taxable compensation, whichever is less. A higher contribution limit applies if the contributor is 50 or older. If married, the contributor can contribute to a separate Roth IRA on behalf of his or her spouse, and a higher contribution limit applies. Roth IRAs cannot be held jointly, but they can be inherited by a spouse or other beneficiaries. Contributions above the annual contribution limit are subject to a 6% excise tax for each year they are in the Roth IRA.

Traditional IRAs, SEP IRAs, and SIMPLE IRAs can be converted into Roth IRAs. Taxes are due on the tax-deductible portion of the IRA’s account balance and any earnings, but the resulting amount in the Roth IRA is tax-free upon qualified withdrawal.

In order to be classified as a qualified distribution, a distribution must be made after a five-year period starting with the first tax year a contribution was made. Qualified distributions can be taken on or after the account holder reaches age 59 1/2, becomes disabled, or when the account holder purchases a first home (up to $10,000 lifetime). Payments made to a beneficiary or the account holder’s estate after the account holder’s death are also qualified.

In contrast, a portion of nonqualified distributions may be taxable as regular income and can be subject to an additional 10% penalty tax. The penalty tax may not be due on nonqualified distributions if the account holder has reached 59 1/2, is disabled, is purchasing a home for the first time, is making distributions as part of a series of substantially equal payments, or if the account holder has significant unreimbursed medical expenses, is paying medical insurance premiums after losing his or her job, is taking distributions that do not exceed his or her qualified higher education expenses, or is a result of an IRS levy of the qualified plan. Beneficiaries of a deceased IRA account holder may also be able to avoid the additional 10% penalty tax.

Roth IRAs can be opened with a variety of financial institutions, including banks, mutual fund companies, and brokerages. Account balances can be invested in a variety of financial instruments, including stocks, bonds, and certificates of deposit, but cannot be used to purchase life insurance contracts.

More retirement questions:
What is a traditional ira?
What is a simple ira?