Roth IRA accounts are a very useful retirement savings plan. All contributions to these accounts are made with money that you have already paid income tax on. No tax benefit is generated from the contribution, but the withdrawals can be tax-free.
All earnings of any type are not taxed within the account. This means that if investments in a Roth IRA account receives a dividend or interest payment, then that entire dividend or interest payment will be deposited in the account and there will be no taxes paid.
Most common security types (stocks, mutual funds etc) are allowed to be purchased in a Roth IRA. These accounts can be set up at various financial institutions such as discount brokerages, banks or mutual fund companies.
Here is some information on completing a Roth conversion from a 401k or Traditional Roth account.
Annual contribution limits are $5,000 if you are 49 or under, $6,000 if you are age 50 or older. These limits are phased out with higher incomes. Someone earning a high income might have a lower contribution limit or no contribution room at all.
For a more detailed look at the 2009 Roth IRA contribution limits. That post also covers the Traditional Roth limits.
Contribution room cannot be carried forward for the Roth IRA. It’s a “use it or lose it” type of plan.
Withdrawals of contributions from a Roth IRA are not taxable but withdrawal of earnings are only tax-free if the participant is 59.5 years of age or older and the account has been opened for at least 5 years.
An example of a tax-free withdrawal
Bob, age 33, contributes $5,000 to a Roth IRA in 2009. In 2011 his investment is now worth $8,000. He can withdraw his original $5,000 (contribution) without any taxes being applied. If he withdraws more than his original contribution then the extra amount will be taxed.
Sue has been contributing to a Roth IRA for many years. Since she is over 59.5 years of age and the account has been opened for at least 5 years, she can withdraw both the original contributions plus any earnings tax-free.
Roth IRA income qualifications – Find out if you make too much money to contribute to a Roth.
Photo credit – Taylor Player