Roth IRAs

Roth IRAs

Definition

 

A Roth individual retirement account (IRA) is a personal savings plan that offers tax benefits to encourage retirement savings. You can contribute up to the lesser of $5,000 in 2011 and 2012, or 100 percent of your taxable compensation to a Roth IRA. In addition, individuals age 50 or older can make an extra "catch-up" contribution of up to $1,000 in 2011 and 2012. Contributions to a Roth IRA are not tax deductible, but the funds grow tax deferred and distributions are tax free under certain conditions.

 

Prerequisites

 

  • You have taxable compensation (i.e., wages, self-employment income) during the year of the contribution
  • Your modified adjusted gross income (MAGI) for 2012 must be:
    • $110,000 or less for a full contribution if your tax filing status is single or head of household (partial contribution allowed, up to MAGI of $125,000)
    • $173,000 or less for a full contribution if your tax filing status is married filing jointly or qualifying widow(er) (partial contribution allowed, up to MAGI of $183,000)
    • $10,000 or less for a partial contribution if your tax filing status is married filing separately and you lived with your spouse at any time during the year (full contribution not allowed)

 

Note: These income ranges are for the 2012 tax year, and are indexed for inflation.

 

Key Strengths

 

  • Qualified distributions are completely tax free (and penalty free)
  • You can contribute after age 70½ (as long as you have taxable compensation)
  • You have flexibility in withdrawing your funds prior to retirement
  • You are not required to take any distributions while you are alive
  • Contributions can be made even if you are covered by an employer-sponsored retirement plan
  • IRAs offer a wide range of investment choices
  • $1,171,650 (as of April 1 2010) (and in some cases more) of IRA assets are protected in the event of bankruptcy under federal law

 

Key Tradeoffs

 

  • You receive no tax deduction when you make a contribution
  • If a withdrawal does not qualify for tax-free status, the portion that represents earnings is subject to federal income tax (and perhaps an early withdrawal penalty if under age 59½)
  • Special penalty provisions may apply to withdrawals of Roth IRA funds that were converted or rolled over from a traditional IRA, SEP IRA, or SIMPLE IRA
  • There is always the possibility that the law will change in the future
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