Roth IRA Basics

You know that preparing for retirement is important. There are a number of different retirement accounts available, and one of those is the Roth IRA. A Roth IRA is easy to open, and nearly anyone can do it. I have a Roth IRA, and am quite happy with it. If you are considering retirement accounts, do your homework and decide which is most likely to work best for you. You can start with learning about the Roth IRA.

Roth IRA vs. Traditional IRA

An Individual Retirement Account (IRA) is a tax-advantaged retirement account. Anyone who has earned income can open an IRA. (If you are under 18 and have earned income, you can have your parents open a custodial IRA, but you can’t contribute more than the amount of your income, up to the limit.) An IRA is an investment account, and you can choose which investments are in your account. You can contribute up to $5,000 ($6,000 “catch-up” if you are 50 or older) in 2010 to an IRA. Your money grows as you earn a return on the investments in the account. Because an IRA is an investment account, it is important to note that you can also lose money in your IRA.

While there are different IRAs for business owners and the self-employed (SIMPLE, SEP, etc.), most people are considered mainly with Roth and Traditional IRAs. The biggest difference between these two accounts is the way contributions are made, and how the money in your account grows over time.

• Roth IRA: With a Roth IRA, your contribution is made after taxes are taken out of your income. However, the money in a Roth IRA grows tax-free. When you go to take qualified withdrawals from your account during retirement, you will not have to pay income taxes on the withdrawal.
• Traditional IRA: When you contribute to a Traditional IRA, that money comes out before taxes, helping to reduce your taxable income. The money grows tax-deferred, meaning that you don’t pay taxes on it until you make withdrawals, at which point the money is taxed at your income rate.

Generally, it is recommended that you use a Roth IRA if you think that your income tax bracket will be higher in retirement, so that you aren’t taxed at a higher rate. If you think that you will be in a lower tax bracket, the recommendation is to reduce your taxes now by using the pre-tax contributions to a Traditional IRA, and pay taxes when your income is lower later on. Of course, it is a good idea to consult a tax professional or financial planner before making your decision.

A Roth IRA also comes with an income limit. Your ability to contribute to a Roth IRA phases out as you make $101,000 to $116,000 as a single person, and as joint filers make $159,000 to $169,000. This year, it is possible to convert your Traditional IRA into a Roth IRA, no matter your income. However, you will be on the hook for taxes related to your Traditional IRA if you do this.

Each person’s situation different. Please talk to a financial advisor and tax advisor for your specific situation.

Opening a Roth IRA

It is relatively easy to open a Roth IRA. Many brokers, including online discount brokers, offer IRA accounts. Many will allow you to open a Roth IRA with as little as $50. You can also invest as little as $25 a month if you agree to direct withdrawal from one of your accounts. You will need your employment information, Social Security Number and bank account information in order to open a Roth IRA. Once it is open, you can make regular investments, and watch your money grow. If possible, it is a good idea to max your Roth IRA if you can.

There are rules about withdrawing money from a Roth IRA, as well as stipulations for tapping your IRA with no penalty.

A Roth IRA can be a good way to save for retirement, and build a tidy nest egg for the future, but with the limits, you will need to start sooner if you rely solely on a Roth IRA for retirement investing.

This is a guest post Miranda Marquit is a journalistically trained freelance writer and professional blogger working from home. She is a contributor for Mainstreet.com, Personal Dividends and several other sites. Miranda is not affiliated or endorsed by LPL Financial. The opinions voiced in this material are for general information and are not intended to provide specific advice and/or recommendations for any individual.