IRAs, or Individual Retirement Arrangements, are not difficult to understand. Learn about Roth IRAs and find out what an IRA is in simple terms.
What is an IRA?
An IRA is not an investment offering potential growth in and of itself. An IRA is a "container" that holds investments earmarked for retirement such as stocks, bonds, mutual funds and precious metals. The IRA "container" is defined by rules for contributions, tax benefits and distributions, while the investments held in the IRA define the actual return you get on retirement savings.
Roth IRAs have different rules for participation compared to a traditional IRAs, and withdrawals taken during retirement are tax-free.
Roth IRA Income, Age and Contribution Limits
- Income Limits: Income thresholds determine your eligibility for a Roth IRA, and you or your spouse must have earned income (such as taxable salaries, wages or self employment income) or taxable alimony income. Currently, if you are single and have modified adjusted gross income under $110,000 per year or you are married and filing a joint tax return and your combined modified adjusted gross income is under $160,000 per year, you can contribute to a Roth IRA.
- Age Limits: Unlike a traditional IRA, there is no age limit for contributing to a Roth IRA. As long as a person has earned taxable compensation, they can contribute to a Roth IRA no matter how young or old.
- Contributions: Currently, those who are less than 50 years old can contribute the lesser of earned income or $4,000 to a Roth IRA while those 50 or older can contribute the lesser of earned income or $5,000. These contribution amounts are reduced if you make contributions to a traditional IRA or to a 501(c)(18) pension plan.
Roth IRA Benefits
While a Roth IRA provides no tax deduction for contributions, qualified distributions are not taxable. If you would prefer to pay taxes on distributions and have a tax deduction this year for contributions, you should consider a traditional IRA.
As long as a Roth IRA is held for five tax years (not calendar years), distributions are tax-free if you are 59-1/2 or older. You can take tax-free qualified distributions from a Roth IRA before you are 59-1/2 years old under these circumstances:
- You are disabled.
- To buy a house for the first time (up to $10,000).
- To use funds for college costs.
- To pay for medical insurance when you are out of a job.
- Other qualified distributions are described in IRS Publication 590.
Roth IRA Conversions
If you have a traditional IRA but would benefit from having your retirement funds in a Roth IRA, you can convert all or a part of your traditional IRA to a Roth if your modified adjusted gross income is not over $100,000. Converting a traditional IRA to a Roth IRA requires you to include the taxable assets being converted in current income, resulting in a higher income tax liability. However, the increase in tax-free growth and distributions of a Roth IRA can substantially offset the larger tax obligation for the year the conversion takes place.
Tax codes occasionally change so check with the financial institution you will open an IRA with, an accountant or the Internal Revenue Service for the most recent rules governing Roth IRAs before investing in one.
