The Encyclopedia
  1. STOCKS
  2. SECURITY ANALYSIS AND RESEARCH
  3. DEBT SECURITIES
  4. MUTUAL FUNDS
  5. INVESTMENT STRATEGIES
  6. RETIREMENT PLANNING

    Determining Retirement Needs

    401(k) plans

    403(b) plans

    Individual Retirement Accounts (IRAs)

    The Roth IRA

    Special Types of Individual Retirement Accounts
The Roth IRA

The Roth IRA is a new type of individual retirement account. The principal difference between the Roth and a traditional IRA is this: while contributions to a traditional IRA are tax-deductible (except in certain cases) and withdrawals are taxed, contributions to a Roth IRA are taxed, but qualified withdrawals are not taxed. For some investors, the inability to deduct their contributions is a tiny price to pay for tax-free withdrawals that could be quite substantial after years of having grown in an account.

As in the traditional IRA, the earnings of a Roth are tax-free while they accumulate.

To help you understand the traditional individual retirement account better, we suggest you read the tutorial called Individual Retirement Accounts.

The Roth IRA tutorial will take you through three areas:

HOW YOU CAN FUND A ROTH IRA

An important part of establishing an IRA is having a custodian for the account. The custodian holds the funds that you contribute. This is an important fact in the case of coin IRAs. The individual does not hold the coins, but the custodian does. The following investments may fund Roth IRAs:

  • Mutual funds
  • Zero-coupon bonds
  • Certificates of deposit
  • Common stocks
  • Savings accounts
  • Unit investment trusts
  • Platinum, gold and silver coins
  • Individual retirement annuities
  • Money market deposit accounts

    Roth IRAs may not be put into some investments:

  • Cash value life insurance
  • Collectibles

    CONTRIBUTION RULES

    As in the traditional IRA, the most one individual can contribute each year is $2,000. The most a married couple filing taxes jointly can contribute is $4,000 per year.

    How much you may contribute in a Roth IRA is also limited. If single, or married and filing separately, you are allowed to contribute the full amount as long as your adjusted gross income (AGI) does not exceed $95,000 per year. Participation in employer retirement plans does not prohibit you. The Roth contribution is phased out when the adjusted gross income exceeds $95,000. You must reduce your contribution by $10 for each $75 your AGI exceeds $95,000. Thus, if you earn $95,750 this year, you may only contribute $1,900 to your account. At $110,000, your allowed contribution drops to $0.

    If you are married and you and your spouse are filing taxes jointly, your limit on adjusted gross income is $150,000. For every additional $50 of AGI you make after $150,000, you must reduce your contributions by $10. Thus, if you and your spouse earn $155,000 this year, you may only contribute $1,000 to your individual account. At $160,000, your allowed contribution drops to $0. Participation in other qualified retirement plans is not a barrier.

    You may simultaneously contribute to a traditional IRA, as long as the total put into both accounts does not exceed $2,000 for you or $4,000 if you are married and filing jointly.

    WHEN ARE WITHDRAWALS ALLOWED?

    Only qualified withdrawals are allowed. Qualified withdrawals are those that do not incur taxes. They are what make the Roth IRA attractive to many investors seeking to fund their retirements. Two criteria must be met for them to be qualified: the individual must be at least 59 ½, and the funds must have been in the account for at least five years.

    The IRS will consider any non-qualified withdrawal to be taxable income. All such withdrawals are subject to income tax on their earnings as well as the 10 percent penalty on early distributions. A six- percent tax is charged on excess contributions (contributions over the legal maximum) to the account. This tax will apply to each year that the excess remains. The 10 percent penalty tax does not, however, apply to the following situations:

  • Disability or death
  • A first-time home purchase up to $10,000

    One is not required to take distributions from a Roth IRA during one's lifetime.

    ROLLOVER RULES

    A rollover is the moving of any investment from its current custodian to another. A Roth IRA must meet the following requirements to keep its tax-deferred status:

    • The account may be rolled over only once per year.
    • The funds must be placed into the new IRA within 60 days.
    • The opening balance of the new account must be equal to the amount of money received from the previous IRA. If it is less, penalty taxes will be applied.
    • The rollover between IRA accounts must be direct.
    A traditional IRA may be rolled over to a Roth as long as the individual's adjusted gross income is $100,000 or less. Any amount that had not been taxed while in the traditional IRA will be taxed when it is rolled over to the Roth IRA.

    This concludes our study of Roth IRAs.




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