With more than one retirement account option it can be hard to know which account would be best for you. If you are setting up your first or fifth retirement account it can be hard to know which is best for you.
The main types of retirement accounts are Traditional IRA, Roth IRA, 401K plans, 403B plans, SIMPLE IRA plans, SEP plans. Understanding the differences between these types of accounts will help you decide which is right for you. 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.
Unlike the Traditional IRA, there is no 70-½ years age limit on making contributions, you may make contributions at any age. One thing to remember is that you must have income in order to contribute. You can’t contribute more than you make nor more than the maximum contribution limit.
Contributions and More to Roth IRAs
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 withdrawals is if you meet the 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 death
- A disability you incur
- 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 that 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.