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Roth IRA Basics

Posted on Monday, September 2nd, 2013 by

A Roth IRA is a retirement savings account with specific tax benefits. Don’t be fooled by the fact that the Roth IRA is designated as a retirement account because you can actually get some of your money out before you hit retirement age. For this reason, it can be a good investment for younger investors who are years away from the retirement age of 65.

Roth IRAs can be established at a bank or through a brokerage account. You must designate that the account is Roth IRA when establishing it. Once a Roth IRA account has been opened, you can buy assets such as stocks, bonds, mutual funds, CDs, and other investments for the account.

An investment (like in a Roth IRA) is considered tax-exempt — that is, you don’t pay taxes on the earnings when you pull the money out of the account. On the other hand, an investment (like in a Traditional IRA) is considered tax-deferred because you pay taxes on the money only when you pull the money out. Some of the specific features of a Roth IRA are described in the following sections.

Roth IRA Contribution Amounts

You can currently contribute no more than $3,000 to a Roth IRA. The information below gives you the contribution maximums for future taxable years for the Roth IRA. The actual amount you can contribute (as opposed to a general contribution limit of $3,000) will depend on your earned income. Because the contributions are made with after-tax dollars, there are no immediate tax benefits. However, in the long run, the earnings in the account are not taxable. IRS Publication 590 is a great guide for all the rules applicable to investing in IRAs.

Tax Year Maximum Annual Contribution
2003 $3,000
2004 $3,000
2005 $4,000
2006 $4,000
2007 $5,000
2008 $5,000
2009 Indexed (i.e. adjusted by inflation)

How Long Roth IRA Earnings Can Accumulate

Your Roth IRA earnings can accumulate in the account until you are 59½ at which time you can withdraw the money (both your contributions and the earnings in the portfolio) without paying any taxes on it if the account has been open for 5 years. You don’’t have to withdraw your money at age 59 ½ — in fact, you can keep contributing to the account until age 70 ½, and you can keep the money in the account after that age in order to earn more on your investments if you’’d like.

Roth IRA Early Withdrawal

You can withdraw your Roth IRA contributions (as opposed to the earnings you’’ve made in the account) before you are 59½ years old without a 10% tax penalty as long as you have had the account opened for five years. You will, however, owe taxes on any earnings (as opposed to contributions) you withdraw before age 59 ½. Penalty-free withdrawals of earnings are allowed after the account has been open for five years in a number of limited instances including purchase of a first home, if you are disabled or payment is made to a beneficiary or to your estate after your death. An additional 10 percent penalty is imposed on withdrawals prior to the expiration of the five year period except in a number of limited instances including purchase of a first home, paying for major medical or higher educational expenses or you are disabled.

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