It's been awhile since Roth IRAs got their comeuppance, it seems. Did they fall out of fashion? Why? Roth IRAs, quite simply, are tax-favored accounts to which qualified taxpayers can make non-deductible, after-tax contributions. Those contributions can grow tax-free, and neither they nor the earnings they generate are subject to tax if withdrawn as a qualified distribution. Pretty cool, right?
The Roth IRA is, like a traditional IRA, designed to help you save for retirement. A traditional IRA, however, can’t offer you the following:
- You can’t be too old to contribute to a Roth IRA. (A person who has reached age 70 ½ by the end of the year cannot make contributions to a traditional IRA.)
- Qualified distributions (those made more than five years after the contribution and taken after the owner has passed age 59 ½) from a Roth IRA are utterly, 100% tax-free. You can also make a withdrawal under certain special circumstances, such as the purchase of a new home.
- Unlike traditional IRA owners, a Roth IRA owner doesn’t have to begin taking distributions from the account at any particular age. Tax-free accumulation can continue ‘til the cows come home.
- Any money the owner puts into the Roth IRA -- as opposed to the earnings generated by those contributions -- can always be withdrawn tax-free. Period. End of sentence. Try that with your traditional IRA.
Taxpayers' ability to withdraw the annual contributions they make to a Roth IRA tax-free at any time means that these accounts can help achieve financial-planning goals in ways the traditional IRA has never dreamt of. Before making any contribution to a traditional IRA, for example, taxpayers must make sure that they can live without those funds for some period of time -- since taxes and major penalties are imposed on any early withdrawals. With a Roth IRA, however, withdrawals before the five-year requirement are tax-free (as long as they consist only of contributions). What’s more, any tax on early withdrawals is imposed only when the withdrawal is included in income.
Worth Noting: Because you can take contribution distributions sans tax, it's crucial that you keep accurate records of the amounts you put into to your Roth IRA. If a withdrawal should happen to be made from the account, you'll be able to prove that it's coming from contributions. (Ahem ... tax-free.)
Roth IRAs can clearly be an important component of both your retirement plan your overall financial plan. Yes, you should avoid taking early distributions from your Roth IRA whenever possible, but the same can be said of any retirement account. The Roth IRA, without question, offers marked advantages over those alternatives.
Josh Michaels is a freelance writer who survives on very little income and carefully considered financial decisions. This combination has allowed him to have fun, travel the world, and start a retirement account – all without the pleasure of holding a full-time job. He can be reached at: joshmichaelsmoney@hotmail.com
