Roth IRA

Roth IRA

An individual retirement plan that bears many similarities to the Traditional IRA. Contributions are never deductible, and qualified distributions are tax-free. A qualified distribution is one that is taken at least five years after the taxpayer established his/her first Roth IRA and when he/she is age 59½, disabled, or using the withdrawal to purchase a first home (limit $10,000), or deceased (in which case the beneficiary collects).

Notes:

Because qualified distributions from it are forever tax-free, some argue that a Roth IRA is more advantageous than a Traditional IRA.

See also: 401K, Extended IRA, IRA, Roth IRA Conversion, IRA Adoption Agreement and Plan Document, Spousal IRA, Traditional IRA

---

Roth IRA

Individual Retirement Account that allows contributors to make annual contributions and to withdraw the principal and earnings tax-free under certain conditions. Maximum annual contributions are $3,000 per year (phasing up to $4,000 per year in 2005 and $5,000 per year in 2008.

---

Roth IRA

A special type of individual retirement account in which contributions are made with aftertax dollars but distributions are tax-free so long as certain requirements including holding period and age are met. All earnings within the account are free of taxation.

Case Study Roth IRAs allow an annual contribution to a retirement account, but unlike a regular IRA the contribution is never tax-deductible. Rather, distributions from a Roth IRA are generally tax-free, so long as certain criteria are met. Individuals and their spouses are eligible to invest in a Roth so long as their adjusted gross income meets stated guidelines. Tax-free withdrawals are permitted if the investor holds the account for at least five years from the date the account was opened and is at least age 59 ¹/₂ . A tax-free withdrawal of up to $10,000 is permitted for a first-time home purchase so long as the required five-year minimum holding period is met. Distributions prior to age 59 ¹/₂ are not taxable only with respect to contributions. In other words, you can always withdraw prior contributions without tax or penalty, a substantial advantage compared to a regular IRA. Withdrawals of interest are taxable and subject to a 10% penalty unless the money is withdrawn because of death, total disability, the purchase of a first home (up to $10,000), higher-education expenses, medical expenses in excess of 7.5% of adjusted gross income, or health insurance premiums for certain unemployed individuals.

Should I choose a regular IRA or a Roth IRA?

The hands-down favorite is a Roth IRA. Now, the money that goes into a regular IRA isn't taxed until withdrawal after age 59 ¹/₂ A Roth IRA is funded with aftertax dollars, but no taxes are levied on the gains when the money is taken out during retirement. One way to look at the tradeoff is to decide whether you'll be in a lower tax bracket in your golden years. If so, you might want to lean toward the regular IRA. However, you will accumulate more savings in a Roth if your tax bracket remains the same or ticks up. The Roth carries other advantages that weigh heavily in its favor. Among them: With a regular IRA you must start withdrawing money at age 70 ¹/₂ . Not with a Roth. You can take out aftertax contributions in a Roth free of tax and penalty (but not the gains) at any time and for any reason. The income eligibility requirements for a Roth IRA are more generous than for the traditional IRA. There are a number of calculators on the Internet for comparing the two products.

Christopher Farrell, Economics Editor, Minnesota Public Radio, heard nationally on Sound Money^®