One of the keys to a retirement planning strategy is sound financial planning. Opening a Roth IRA is one of the more common steps in planning for retirement finances. An IRA is a retirement account that provides tax benefits to assist people with investing and saving for their retirement years. While an IRA Roth does have significant tax benefits, it does also come with some obligations you should understand as you sign up. Some of these obligations include guidelines to when money can be withdrawn without a penalty, limits on contributions and having income that is eligible for the account. This article breaks down the benefits and rules that come along with opening a Roth IRA.
Why is a Roth IRA a Smart Choice?
A Roth IRA is different from a traditional IRA in that instead of getting a tax break upfront, you receive the tax break down the road on the money you’ll eventually withdraw during retirement. This means that if you expect your tax rate goes up, a Roth would have been preferable, while if you tax rate goes down, a Traditional would have been the better choice – there’s no simple universal answer as to which is the better bet for every individual.
Opening a Roth IRA thus makes a lot of sense for those who have the longest time to save and expect their tax rates to go up over time as a result of their career trajectory – young people beginning to save for retirement – because their money can grow tax-free for a long time.
Ready To Begin?
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Here are the key components of a Roth IRA you need to understand: taxes, contributions, and distributions.
When it comes to taxation, there are some important considerations to be made regarding Roth IRA accounts. With a Roth IRA the contributions made to the retirement account are not tax deductible as they are with a traditional IRA. The trade-off comes when it is time to start collecting on the Roth IRA. Unlike the traditional IRA, a Roth IRA has tax free distributions. However, the distributions must meet a few qualifying factors. Investment gains are also tax free on a Roth IRA as long as the account owner receives the funds as a part of a qualified distribution.
The level of annual contributions allowed for a Roth IRA will depend on a few factors. The maximum amount allowed for an individual is $5,500 as of the tax year 2013. For a married couple filing jointly or a qualified widow the maximum is currently set at $11,000. Some factors may disqualify the individual from the maximum contribution amount.
One factor that can reduce the amount of contributions allowed to an IRA Roth would be if the individual has a retirement plan through their work. Another factor is the amount of earned income the individual or married couple had during the tax year. A single person who earned less than $112,000 is eligible for the maximum contribution. Individuals earning between $112,000 and $127,000 will be eligible for a reduced contribution amount. A married couple that files jointly is eligible for the maximum contribution if they earned less than a combined income of $178,000. For married couples earning between $178,000 and $188,000 a reduced contribution level is available.
Some of the key benefits to the Roth IRA come when it is time for the individual to collect on their retirement account. Qualified distributions are tax free because the account’s owner already paid taxes on the contributions. Another benefit to the distributions of a Roth IRA is that the individual does not have to take any minimum distributions if they don’t need or want to.
For a distribution to meet the tax free qualification it must meet a few simple guidelines. The first rule applies to how long the account has been active. To qualify for the tax benefit the account must have been open for at least five years starting with the first tax year it was opened. The next is in regard to age. The account holder must be at least 59.5 years old when they collect the distribution for it to qualify for the tax benefit. The individual may apply for an exemption to the age requirement if they become disabled before they reach the qualifying age.
by Susan Lyon