Welcome to Roth IRA Rules and Guidelines

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.

 

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