Roth IRA

In 1996, the US government created a new type of retirement account called a Roth IRA that allowed people to set aside after tax dollars and then withdraw the money tax free at retirement. These accounts have a lot of advantages over a traditional IRA, and this article describes the pros and cons of these types of accounts.

Roth IRA Benefits

First, when you withdraw money from a Roth at retirement, you will not owe any taxes. So even if you put in $100 at some point, left it alone for 30 years, and it grew to $10,000, you would not pay any taxes on either the principal or the gains.

Second, you can withdraw your contributions to a Roth at any time without penalties or taxes, regardless of your age and how long the money has been in the Roth.

Also, provided that you meet certain criteria, you can use Roth contributions to buy a principal residence.
Rules
Any gains that the contributions earn must stay in the Roth until you have turned 59 1/2 AND you must have held the account for more than 5 years to withdraw your gains without taxes or penalties.

If you become disabled or die, contributions and gains can be withdrawn at any time without penalty.

There are income limitations to contribute to a Roth. Check here for current income limitations and IRA contribution limits.

Advantages of Roth IRA vs Traditional IRA

* Since you pass up a tax deduction now, with the Roth, you can potentially pay a lot less in taxes in the long term.

* Roth IRAs are inherited by your beneficiaries without incurring income taxes as long as the distribution started more than 5 years after opening the account. Estate taxes still apply.

* With the Roth, you are never required to begin taking withdrawals. With the Traditional IRA, you must start taking withdrawals at 70 1/2 whether you want to or not.

* You have access to your contributions (but not earnings/gains) at any time without taxes or penalties no matter how old you are or how long the money has been in the account.

* As much as $10,000 in earnings can be used to buy a principal residence as long as the Roth owner hasn’t owned a home within the last 2 years.

* Income taxes will not deplete your account when you retire and start taking distributions.

Disadvantages of a Roth IRA vs Traditional IRA

* Traditional IRA contributions receive an immediate tax break in the year that you make the contribution. With the Roth, you must wait until you withdraw the money to get the tax benefit.

* To receive your tax benefit with the Roth, you must have withdrawn all of the money and exhausted the account to receive the entire tax benefit. If you die early, you didn’t receive the immediate tax break you could have gotten with the traditional IRA.

* The government could change the rules in relationship to the Roth account before you are able to take tax free distributions at retirement.

* Income limits on the Roth may make it impossible to use this type of account.