The Roth IRA, named after Senator William Roth, Jr., is the best investment deal to come along since the 401(k). Despite the Roth IRA's many benefits, millions of investors are still not taking advantage of this new IRA.
How does the Roth IRA differ from the traditional IRA?
In a traditional IRA, earnings on contributions grow tax-deferred, which means they are subject to taxes when withdrawn. In contrast, although the annual contribution to a Roth IRA is not tax deductible, the account's value is not taxed upon distribution, including earning. In other words, your money grows tax-free.
What are the benefits of the Roth IRA over a traditional IRA?
As mentioned, your money grows tax free in a Roth IRA, not tax-deferred as in a traditional IRA. In order to withdraw your money tax free, your account has to have been open at least five years and your withdrawal occurs either after you reach 59.5 or due to disability, death, or if the money is used for expenses under the "first-time home buyer" rule. Another advantage of the Roth IRA is that you aren't required to withdraw money ever, even after the age of 70.5. With a Roth IRA, if you die, your beneficiary won't have to pay income taxes on money withdrawn from the account. This makes a Roth IRA an interesting estate-planning tool.
What are the downsides to Roth IRAs?
If you withdraw your money before your Roth account has been open five years, your earnings may be subject to federal income taxes plus a 10 percent penalty. You also don't get a federal income tax deduction for money you contribute to a Roth IRA.
Can I convert an existing traditional IRA into a Roth IRA?
Yes, as long as your adjusted gross income isn't more than $100,000 for the year in which you convert. Obviously, being able to shift from tax-deferred growth to tax-free growth is a big incentive to convert from a traditional IRA to a Roth IRA. However, when you convert a traditional IRA, you incur a tax liability. The size of the tax liability differs depending on whether you are converting deductible or nondeductible IRA funds. If you are converting IRA funds that were tax-deductible upon contribution, the entire amount is considered ordinary income for tax purposes. In other words, if you are converting a deductible IRA of $28,000 to a Roth IRA, you'll have to pay taxes on the full $28,000. If you are converting a nondeductible IRA, only the earnings are subject to tax, not the contributions, which were made with after-tax dollars.
How do I get started investing in a Roth IRA?
Once you have determined that a Roth IRA makes sense for you, the next step is to choose your investment. If you go with mutual funds, contact the fund and request enrollment information for the mutual fund, as well as an application for a Roth IRA. When you get the fund enrollment and Roth IRA materials, fill them out and return them to the fund. Make sure you include your check for the initial investment. Many mutual funds have lower investment minimums for investors opening IRAs, so individuals with limited finances still may find it possible to get started investing in a Roth IRA.
