Introduction to Roth IRA

The United States has several Individual Retirement Accounts (IRA), which Americans use to save up for their retirement. In this article we introduce the Roth IRA, named for its chief legislative sponsor, Senator William Roth of Delaware.

What is Roth IRA?

A Roth IRA is an individual savings plan that accrues earnings on a tax-free basis and offers no tax deferral. Contributions can be made up to a specified limit, but it is not deducted on your income tax unlike in traditional IRA. Withdrawals are tax-free within certain limitations. Any individual can establish and fund a Roth IRA in the year they have taxable compensation or self-employment income unless their income reaches a certain level.

Who are eligible for a Roth IRA?

Because Roth IRA offers tax advantages, Congress has limited who can contribute to a Roth IRA depending on a person’s income. A taxpayer can only contribute the maximum amount allowed if their Modified Adjusted Gross Income (MAGI) is below a certain level. Once MAGI hits the top of the range, no contribution is allowed at all.

For instance, a single filer should has an annual income of up to $99,000 to qualify for a full contribution, while an income between $99,000 to $114,000 would only make him qualified for a partial contribution. Meanwhile, a married couple filing for their Roth IRA separately are not allowed to contribute fully, except if they do not live together for more than a year.

However, once a Roth IRA is established, the balance in the account remains tax-sheltered even if the taxpayer’s income rises above the threshold.

How to open a Roth IRA?

The account must be set up with a bank, credit union, brokerage, or any other financial institution that is approved by IRS, wherein you would receive the IRA disclosure statement, the IRA adoption agreement, and a plan document. A Roth IRA can be established at anytime during the year but contributions for a tax year must be made before the taxpayer’s filing deadline.

Advantages and disadvantages of Roth IRA

There are several advantages that Roth IRA has over traditional IRA. For instance, contributions can be made after age 70 ½ unlike in traditional IRA; eligible individuals may contribute up to a specified annual limit; contribution eligibility is not restricted by active participation in an employer’s retirement plan; and that withdrawals of earnings upon death or disability, as well as buying a home for the first time or simply being over 59 ½ of age, are tax-free provided a five-year wait has occurred.

Roth IRA also has its share of disadvantages, such as taxable premature withdrawals that are in excess of contributions, limited contributions, and a "phase-out" rule for persons with higher income.

 

Posted by Ardent Editor on May 19 2008 in IRAs

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