A roth IRA is an Individual Retirement Account, through which you can invest in securities, usually common stocks or mutual funds. Other investments including derivatives, notes, certificate of deposits and real estate are also possible.
The total contributions allowed per year to a Roth IRA account is limited to $5000 for adults aged 49 and below and $6000 for individuals aged 50 and above. Starting in 2009, contribution limits will increase in $500 increments based on inflation.
Unlike a traditional IRA, when you contribute to Roth IRA, the contribution is not tax-deductible or you are paying tax upfront. Likewise, in contrast to a tradional IRA where you pay income tax on the entire amount of your withdrawal, in a Roth IRA you pay no further taxes on your withdrawal. Of course some restrictions do apply, the restricitons being that at the time of withdrawal, the account must have been opened for 5 years and that the owner's age is at least 59 ½.
What are the advantages of Roth IRA?
1. Traditional retirement accounts allow you to delay paying tax and that helps the account grow faster, but you'll have taxable income later when you withdraw the money. The more the account grows, the more tax you end up paying.In a Roth account, all the money is working for you and your retirement nest egg is completely tax-free.
2. Direct contributions to a Roth IRA may be withdrawn at any time with no tax or penalty, since they have already been taxed. This means that if you contribute $5000 to your IRA account and after one year your account grew to $6000 value (the value of the underlying stocks increased or you got dividents or whatever) you can take your $5000 back anytime without any penalty or tax.
3. If you have maintained your account for 5 years and your age is 59 1/2 or above, you can withdraw your earnings(when $5000 grows to $6000 after one year, $1000 is your earnings and $5000 your contribution) as well as contributons. Unlike a traditional IRA, there are fewer restrictions and requirements for withdrawing your money. The minimum distribution rules that apply to traditional IRAs beginning at age 70½ don't apply to Roth IRAs.
4. Roth IRA is much more simple than the traditional IRA. With a traditional IRA you need to report a deduction on your 1040 form when you make a contribution and on withdrawal you need to report the entire amount as taxable income. However in Roth IRA since you are already paying your taxes, there is nothing to report.
5. You have already taken care of the taxman. This means that you need not worry if the tax rates go up in future.
6. Up to $10,000 in earnings can be withdrawn tax-free if the money is used to acquire a principal residence. This house must be acquired by the Roth IRA owner, their spouse, or their children.
7. If a Roth IRA owner dies, his/her spouse becomes the beneficiary of that Roth IRA while also owning a separate Roth IRA, and the spouse is permitted to combine the two Roth IRAs into a single account without any penalty.
8. You can contribute to Roth IRA even if you contribute to another retirement plan such as 401K.
9. The savings in a Roth IRA account is more beneficial to your children if you have enough wealth to be concerned about the estate tax.The estate tax applies to your total assets at death, including assets held in a traditional IRA or a Roth IRA. When your children or spouse receive a traditional IRA, they'll have to pay income tax on the amounts they withdraw. The value of what you transfer to them is reduced by the amount of the taxes. But if they receive a Roth IRA, they get to keep the amounts they withdraw.
10. Roth actually lets you to shelter more 'real' money.For example when you contribute $10000 towards your retirement income in a Roth account you can withdraw all $10000 whereas in a traditional IRA account you get only $10000 minus the tax.
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