With more than one retirement account option it can be hard to know which account would be best for you. It doesn't matter whether you are setting up your first account or your fifth account it can still be hard to know which account you'd like to set up. The main different types of retirement accounts are: Traditional IRA, Roth IRA, 401K plans, 403B plans, SIMPLE IRA plans, SEP plans, SARSEP plans are some of the more popular types of retirement accounts that can be set up. It is important to understand the differences between these types of accounts as each one might mean that you deal with a specific situation differently. It is also important to know how each one of these differs when you are setting up a self directed IRA
or a self directed 401k
. Today we will be talking about the basics of a Roth IRA.
Roth IRA Basics
A Roth IRA gives you the ability to save and invest your after-tax dollars, let the investment grow completely tax free, and withdraw your principal and earnings tax-free if the Roth has existed for at least five years. (For certain reasons you may be subject to a 10 percent penalty on the earnings if taken before age 59 ½.) In other words, once your after-tax dollars go into the Roth, neither those dollars nor any future earnings on the dollars are ever taxed again, a very powerful feature. And, unlike the Traditional IRA, there is no 70-½ years age limit on making contributions, you may make contributions at any age. One requirement to making contributions is that you must have some earned income which is equal to the amount you want to contribute, and then there is a maximum amount that you may contribute. You can't contribute more than you make nor more than the maximum contribution limit.
The deadline to contribute to a Roth IRA for a particular tax year is generally April 15 of the following year. When this date occurs on a weekend or a legal holiday, the following business day becomes the deadline. Tax return extensions do not extend this deadline, it’s always April 15th of the following year. When an individual makes a contribution to his or her Roth between January 1 and April 15, for the previous tax year, this is frequently referred to as a “carryback contribution”. See the page 4 topic “Contribution Rules For Both Roth and Traditional IRAs” for contribution limits.
Withdrawals a.k.a. Distributions
You may make tax-free and penalty-free withdrawals from your Roth IRA if you meet two conditions. First, your Roth IRA must have been open for a minimum of five years. Second, the withdrawal must be made because of the occurrence of one of the following events:
You have reached age 59-½
The only other way you can take any withdrawls is if you meet the following IRS provision which allows partial withdrawals to begin at almost any age and to continue for a specific time frame. This provision is called a 72(t). Some of the exceptions are
Your first home purchase
Check out the IRS website for more information about a 72(t)
Distributions or withdrawals that meet the above requirements are referred to as "qualified distributions." While you may take distributions from your Roth IRA at any time, distributions which are not qualified distributions may be subject to taxes (and in some cases early distribution penalties) to the extent they exceed your combined contributions to the Roth IRA.
You are not required to take withdrawals at age 70-½ or any other age as you are with a Traditional IRA, another very powerful feature. You can leave everything in the Roth, continuing to grow tax free, and pass the Roth after your death on to your heirs also income tax free. However, the amount left in the Roth after death will be subject to estate or other death taxes if the estate is large enough to hit the taxable minimums.
Author: Ben Barker, Self Directed IRA Professional