Welcome to Roth IRA Rules and Guidelines

by kristine on September 6, 2010

Roth IRAs are my favorite investment vehicle for many reasons.  If you’re not familiar with them yet, a Roth IRA is an individual retirement account available under the US tax code.  Named after it’s strongest supporter Senator William Roth, the Roth IRA was established by the Taxpayer Relief Act of 1997, and investors were first allowed to open accounts in 1998 with a maximum annual contribution of $2,000 (today investors can contribute up to $5,000 per year, $6,000 if you are over age 50).

The main benefit of the Roth IRA, and the biggest feature that differentiates it from it’s older sibling the Traditional IRA, is the fact that withdrawals from Roth IRAs are tax free.  Even more importantly, the money you earn in a Roth IRA is never taxed (as long as you follow the Roth IRA distribution rules).

With most tax-advantaged retirement plans, you receive a tax benefit up front and you pay taxes on the money when you withdraw it.  This is known as tax-deferral.  With Roth IRAs, you don’t get a tax deduction when you contribute to your account; however, you don’t pay taxes on qualified withdrawals.  This allows your earnings to grow tax-free.  No other retirement account offers tax free earnings!

Because of the unique tax features of Roth IRAs, these are very flexible investment vehicles.  While they were created with the purpose of saving for retirement, the generous tax rules governing the Roth IRA allow you to use these accounts for many financial goals, including saving for college, your first home, setting up an emergency fund, or yes, even retirement.

As with the other IRAs and tax advantaged retirement plans available in the US, the Roth IRA is governed by the IRS.  There are many rules and requirements that must be met to get the full advantage these investments offer.

Learn more about Roth IRAs by visiting our most popular resources below:

Roth IRA Contribution Rules

Because Roth IRAs (and traditional IRAs for that matter) have tremendous tax advantages, the IRS limits that amount that can be contributed to these accounts each year.  The Roth IRA contribution limits are the same as those for the Traditional IRA.  The contribution limit for 2011 is $5,000; however individuals age 50 or older can contribute an additional $1,000 each year.  Anyone can contribute to a Roth IRA, as long as they have earned income.  To learn more about the Roth IRA contriubtion rules, please visit Roth IRA Max: Is There a Limit to How Much I Can Put in my Roth IRA?

Roth IRA Withdrawal Rules

Did I mention that Roth IRAs are my favorite investment vehicle?  That’s because qualified withdrawals are tax free, making the Roth IRA one of the most tax advantaged investment account available.  Because the tax rules governing Roth IRAs are so favorable, you can use your Roth IRA to save for many financial goals including saving for college, saving for a down payment on a home, or saving for vacation or a rainy day fund.  Roth IRAs means IRAs aren’t just for retirement anymore!  But, to get those tax benefits, you have to follow certain rules.  To learn more about the Roth IRA distribution rules, and how you can access the money in your Roth IRA at any time without worrying about paying taxes or penalties, please visit Roth IRA Withdrawal Rules: The Basics.

Converting to a Roth IRA

Because Roth IRAs have so many tax benefits and are so flexible, many people have been converting their traditional IRAs to Roth IRAs.  Some people are converting because they believe they will be in a higher tax bracket later (or that taxes in general will be higher later), while others are converting because their income is too high to contribute new money to a Roth IRA.  In 2010, the income limit for converting to a Roth was eliminated, making this strategy even more popular.  However, there are many factors you should consider before doing a Roth IRA conversion, so before you leap, please take a look at Should You Do a Roth IRA Conversion?

Traditional IRA vs. Roth IRA

If you’re still not quite sure if a Roth IRA is right for you, you might need a refresher course on the difference between a traditional IRA and a Roth IRA.  Both IRAs are retirement savings vehicles, and both offer tax advantages.  The biggest difference is the timing of those tax benefits.  Traditional IRAs offer a tax deduction up front.  As long as you meet the income limits and other eligibility requirements you can deduct the amount contributed to your traditional IRA on your tax return for an immediate tax break.  With Roth IRAs, the tax benefit is at the back end; you don’t get a tax deduction when you contribute to the account, but you get to take withdrawals tax free as long as you follow the rules for qualified withdrawals.  As much as I love Roth IRAs, I realize that a Roth may not be best for everyone.  Which IRA is best for you will depend on your own unique situation.



401K vs Roth IRA – Which Should You Invest In?

by kristine on November 3, 2011

The Roth IRA vs 401K Debate

There are many factors to consider when determining whether to invest in a 401k vs a Roth IRA.  Both retirement plans have benefits to offer. If your budget allows, it is best to invest in both a 401k through your employer and a Roth IRA on your own. However, that is not financially feasible for many people, so you may find yourself wondering whether one is better than the other.

A Quick Primer on the 401K

Most people are familiar with 401K plans, a retirement plan offered by many employers. With a 401K, you get to elect a percentage of your salary to save and invest, and that part of your salary goes into your 401k before it is taxed, which helps reduce the taxes you pay on your income tax return.

Historically, companies have often matched the amount you save for retirement. For example, if you invested four percent of your salary into your 401k, your company might also contribute four percent on your behalf. Financial planners often refer to the company match as “free money” because it is compensation that your employer is providing above and beyond your regular salary.

While traditionally 401K plans have been pre-tax, some companies also allow after-tax contributions or even Roth 401K options.

How a Roth IRA is Different

A Roth IRA is a little different than the traditional employer sponsored retirement plan. A Roth IRA is a retirement account you set up on your own, with an initial deposit and then a regular contribution which you determine. You need to have earned income in order to contribute to a Roth IRA, even though it’s not an employer sponsored account.

The money you put into a Roth IRA is already taxed, so you don’t get an immediate tax benefit like you do with a 401K. However, one of the greatest features of the Roth IRA is that you will not have to pay tax on withdrawals from your Roth IRA, as long as the distribution is “qualified”.

However, another benefit of the Roth IRA is that you can take out any contributions that you have made without taxes or penalties. So, if you have a balance in your Roth IRA of $30,000, and $24,000 of that is based on contributions you have made, you can take the full $24,000 out at any time without penalty. You can’t withdraw the earnings until you reach age 59-1/2, but you always have access to your contributions.

Once you reach age 59 1/2 and your Roth IRA has been in existence for at least five years, then you can withdraw contributions and earnings without paying any taxes or penalties.

Which One is Right For You?  How About Both…

So which retirement account is best for you?  With profits dwindling and the cost of running a business growing, many companies are taking away the matching 401k contribution, making 401K plans less appealing than they have been. On the other hand, 401K plans make saving easy since the money comes right out of your paycheck, and they do offer valuable tax deferral so they can still be beneficial even if you don’t get a company match.

Roth IRAs are very flexible – thanks to the rule that allows you to take your contributions out at any time without paying any taxes or penalties – which makes them great not only for saving for retirement but for other financial goals as well.  Many people use Roth IRAs to save for their first home, to pay for college, or even as their emergency fund.  And the tax free withdrawals (for qualified distributions) is hard to pass up, making Roth IRAs valuable investment vehicles as well.

In fact, both plans have many benefits, and you may benefit from having both types of accounts instead of choosing just one.  With tax laws constantly changing a strategy you might consider is to keep your 401k in place, but open a Roth IRA as well.  This will allow you to diversify your portfolio from a tax standpoint (just like you do to reduce investment risk), and also provides different options for how to manage your money and when to withdraw it after you retire.

If you cannot do both, and are unsure of which plan is best for you, talk to a financial planner. A qualified professional can help you decide the 401k vs Roth IRA dilemma.


Roth IRAs and Taxes: Diversifying Your Portfolio for Taxes

October 19, 2011

As a financial planner I’m always telling clients they need to diversify. If you didn’t understand the danger of having all of your eggs in one basket before, the volatility we’ve experienced in the market should have you convinced by now. Well taxes are a lot like investments when it comes to the need to diversify. Tax laws change just like the stock market does, so depending on one tax strategy is similar to investing in just one stock.

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Roth IRA Recharacterization: Last Chance for a Roth Do-Over

October 13, 2011

Time Running Out to Recharacterize a Roth IRA Conversion If you converted a traditional IRA to a Roth and are unhappy with that decision, there’s still time for a do-over… but not much! Roth IRA conversions can be recharacterized back to a traditional IRA, but only for a certain period of time. In general you [...]

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