Unlike the 401(k), Roth IRA is a retirement plan under United States law and not provided by a company. The plan is generally non-taxed unless certain conditions are met. IRA stands for Individual Retirement Account while the “Roth” part stands for William V. Roth Jr. who was a sponsor of legislation creating the said retirement plan.
Roth IRA is a brokerage account designed to fund one’s retirement. It also allows you to trade securities as with any brokerage investment account. Unlike other brokerage accounts though, IRA’s have tax benefits. With Roth IRA, you pay taxes for your contribution before it comes in to the account.
Types of IRAs8
There are generally four types of IRAs and each of them comes with their own set of benefits. Traditional and Roth IRAs are the types that are usually opened by individuals while the remaining two, the Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) are offered by companies or employers.
All of them are “fully vested” which means that all contributions and earnings are owned by the individual including those that came from their employers.
Roth vs Other IRAs
For traditional IRAs, you are required to have earned income and not be more than 70 years of age to make a contribution while with Roth IRAs, you are only allowed to make a contribution if your income fits into a certain bracket or ceiling.
Another glaring difference has something to do with tax incentives. Contributions you made through traditional IRAs can be subtracted from your taxes (both state and federal) and these deductions should be made within the same year the contribution was given.
Roth IRAs on the other hand, do not provide tax breaks on your contributions. Earnings and withdrawals are free of tax which means you don’t have to pay taxes for the money you withdraw upon retirement.
Benefits of Roth IRA
There’s a reason why Roth IRAs are considered by some to be the best retirement plan available and for a good reason. Roth IRAs have a lot of benefits that gives an individual more advantages than disadvantage and here are some of them:
- Maximum contributions per year can go as high as $5500 and can be used on top of a 401(k).
- If you are above 50 years of age, you can contribute $1000 more per year as catch-up contribution
- Since you’re contributing after-tax money, the taxes you pay for are locked at your current rate and not the rate that will be in effect when you retire which can get you a lot of savings especially if you;re expecting your tax rate to go up.
- You can withdraw your contributions before you retire without penalty or tax since you’ve already settled your taxes on your Roth contributions. You can, and will be taxed though, if you withdraw the earnings from investment so be careful.
- Roth IRA money can be used to pay for college expenses (qualified ones) without penalty. There is typically no limitations as to how you would like to use your contributions but do note that distribution of earnings may be taxed so again, it pays to know and understand how Roth IRA works before you perform certain actions.
The Only Letdown
With all the benefits Roth IRAs bring, there’s only one disadvantage or counter-benefit that it has and that is that it’s not available to high earners due to their tax situation.
How to Open a Roth IRA?
You can easily open a Roth IRA account from banks and brokers who offer it but you have to look for one that offers low account fees and reasonable account minimum.
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