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Roth IRA: All You Need to Know

Jeff WilliamsJeff Williams ·

You probably have heard about Roth IRAs and their huge tax benefits, and you might have wondered if they can be a good fit for you. Well, I am here to demystify Roth IRA, the individual retirement savings account that has quickly become the talk of the town. Naturally, you first want to know what is a Roth IRA.

What is a Roth IRA?

In simple terms, a Roth IRA is a special retirement account that comes with substantial benefits, chief among them tax-free withdrawals in retirement. Funds you deposit to your Roth IRA account are, however, not tax-deductible, unlike conventional IRAs. You additionally enjoy tax-free growth on your contributions and earnings.

Does the name William Roth ring a bell? Well, the former senator (Delaware) is the brainchild behind Roth IRAs, hence the name. With the Roth IRA definition out of our way, let’s now preview what’s ahead:

  • How to get started on a Roth IRA.
  • What is a Roth contribution?
  • How to make a Roth Contribution?
  • Roth IRA contribution limits.
  • Traditional IRAs vs. Roth IRA.
  • Pros and cons of Roth IRA accounts.
  • Useful tips to help you build wealth via a Roth account.

Of course, there’s a whole lot more to learn, so come with me.

How does Roth IRA account work?

To lay the groundwork for everything else, we will briefly focus on how Roth IRAs work.

You already understand a couple of things, including what is a Roth IRA account and its famous tax advantages.

So, we shall open this section by diving straight to how you get started.

How to Get Started on a Roth IRA

Roths are open to anyone with an earned income (but must not be above a certain limit as set by the IRS). If you’re employed, you register and maintain a Roth IRA account separately from your other employer-sponsored retirement schemes like 401(k).

Once you open a Roth IRA account (you can easily do this online from most brokerages or banks), you grow it primarily by making regular contributions (spousal contributions accepted). A Roth is a terrific investment plan for your retirement since accumulated contributions continue compounding even in years you’re unable to add funds.

Okay, a Roth IRA lacks a fixed interest rate like, let’s say, regular bank savings accounts. All the same, you can potentially earn massively considering the available investment opportunities, as you will discover next.

Investment Options Within a Roth IRA

A significant reason why IRAs (Roth and traditional) have become a real buzzword in the last couple of years is the vast selection of rewarding investment options. In most cases, you can supercharge your wealth-building efforts by taking up safe, but profitable, investment opportunities such as mutual funds and bonds using your Roth IRA contributions.

Smart investors diversify, and you can spread your wings to stocks with reliable dividends, CDs, ETFs, and money market funds to shield your yields against market volatility. This is a smart way of topping up your retirement savings, especially if you’ve maxed out your 401(k) dollars.

This brings me to a key matter: Roth contributions and associated rules.

What are Roth Contributions?

The short answer is that they are funds you stash away in your IRA account. Importantly, rules dictate that you contribute earned income.

This can be:

  • Wages
  • Bonuses
  • Salaries
  • Commissions
  • Other amounts you are paid on account of the services you render.

If you’re self-employed or in a business partnership, this could be your net business earnings, less allowable deductions, and self-employment taxes. The government also permits contributions from the money you receive as:

  • Child support
  • Alimony
  • Divorce/separation settlement.

If you already hold other assets, you can fund your Roth from transfers, conversions, and rollover contributions.

Quite interesting options there!

Even so, you should exclude incomes from properties such as rent and maintenance fees besides interest income, capital gains, and dividends, as well as earnings from annuities and pension plans.

Roth IRA Contribution Limits 2019

Roth IRAs have contribution restrictions, and you can only be allowed to contribute up to $6,000 annually, or $7,000 if you are 50 or older. Keep in mind that you can never contribute beyond what you make.

How to Make a Roth Contribution

You make a typical IRA contribution in cash (or checks) and not securities or assets according to the schedule you select when opening an account.

Traditional IRAs vs. Roth IRA

You might be wondering how a Roth IRA works and what exactly are its structural differences with standard IRAs. There are a couple of things you need to know here, starting with the tax structures. In a Traditional IRA, you’re granted a tax deduction upfront and pay when withdrawing money from the account (in retirement).

This means that you only ‘defer’ your tax obligation to a later date. As a result, your retirement savings can be consumed by future hikes in tax rates. Conversely, your Roth contributions are already taxed, and your future tax rate is effectively zero.

And that’s what makes it such an attractive option. What’s more, the two contrast significantly in the controlling regulations, including distribution and withdrawal rules.

This table summarizes the remaining major differences.

  Traditional IRAs Roth IRAs
Income limits No income limits(high earners might not, however, miss out on upfront tax break). Subject to income limits. For instance, the allowed income phase-out range is $122,000–$137,000 (single filers) in 2019.
Age limits No contributions allowed after you turn 70½. No age limits in IRA accounts. You can contribute for life.
Minimum distribution rules You MUST make distributions after turning 70½. No such minimum distribution requirements.
Withdrawing your money All withdrawals taxed. Plus, a withdrawal when you’re under 59½ attracts an additional penalty. You can withdraw your principal at any time without being penalized. Some rules, however, apply to qualify to withdraw your earnings for free.

 

Roth IRA Eligibility Rules

It might sound promising, but are you eligible? Generally speaking, the only precondition is that you should be making some income. But as I had hinted earlier, there’s a catch:

If single, you can only contribute to Roth IRA if you have a MAGI (modified adjusted gross income) below $137,000. On the other hand, couples filing taxes jointly can join the plan with a markedly raised MAGI of $203,000 (maximum). Your actual maximum contribution will depend on specified income phase-outs.

Pros and Cons of Roth IRA accounts

A fundamental question if you’re reconsidering your retirement plan is whether to stick to the old or dive straight into an IRA Roth account. To guide your decision, here are some unique features of IRA Roth.

  • You can contribute (and keep enhancing your account) forever if you play by the rules.
  • You will not be compelled to make distributions at any point.
  • You are free to cash out when faced with financial emergencies.

In addition:

  • You can pass the benefits to your heirs.
  • Roth IRAs have an elevated effective contribution limit.
  • You can settle qualified college expenses using your Roth IRA money without incurring a premature distribution penalty

At this point, you can clearly see that the tax advantage is just the tip of the iceberg. Nevertheless, there are a few issues to worry about:

  • The value of your investment might take a hit during periods of market turbulence. It all boils down to how well you have balanced your investment basket.
  • You still have to meet strict conditions in some instances, including early withdrawals of earnings.
  • You won’t use your IRA as loan collateral (but you can, of course, withdraw money at any time).

But nothing is perfect, not least investment plans. Back to the burning question:

Is a Roth IRA or a Traditional IRA Better?

Overall, a Roth IRA works best if you fear the prospect of paying higher taxes than you do presently in your latter years. The good thing is that the government can allow you to convert your traditional IRA funds (and certain tax-free IRA funds) to Roth IRA subject to payment of due income tax. Better still, you can run both a Roth IRA alongside qualified retirement plans like 401(k).

That’s pretty powerful.

Useful Tips to Help You Build Wealth Via a Roth IRA Account.

  • Find the right brokerage when starting. The basic questions to ask what’s the trading costs (commissions and fees) and if you’ll access your preferred investment vehicles.
  • Because its biggest strength is taxation, the best place to invest your Roth IRA account funds is in investments that generate highly taxed incomes like dividends, interest, and capital gains.
  • To maximize the Roth IRA favorable taxation system, hold investments that usually trigger considerable taxes for as long as possible.
  • Always consult your financial advisor before making huge moves. His/her wealth of knowledge can be handy in avoiding headwinds.

To Wrap Up

The little gains you reap from Roth IRA’s friendly taxation provisions can cumulatively add up to a substantial fortune over the years. But ultimately, you have to make the first move. The best way to get started is to appraise your current status and your other retirement plans (if any). Our investment professionals have more to share if you want further guidance.

Take action now and schedule a free Roth IRAs webinar at your most convenient hour here.

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