A Roth IRA is the darling of all IRA’s. What makes them so attractive is that they are exempt from any taxes. The key word in the last statement is EXEMPT. That means that any withdrawals you make will be free of any tax burdens. Think about it. You will pay $0 taxes on your withdrawals and $0 taxes on the earning. To be more emphatic, zero, zilch, nada will be the ultimate amount of your taxes. You need only to play according to the rules. The rules are clear enough. The Roth IRA needs to have been in force for at least five years, and you must have reached age 59 ½. That’s it.
On the other hand, your contributions to your Roth IRA are NOT deductible. You are not able to deduct any portion of your them from your stated income for tax puposes. Anyone can participate in a Roth IRA plan, including single filers and married couples. There are limits on income: $95,000 for a single person and $150,000 for a couple.
The contributions to your fund are allowed to grow and compound over the years. Left untouched and untaxed, the multiplier factor kicks in and your money will grow exponentially over the years. The longer your cache is left alone, the more your principal will grow. Never underestimate the power of compounding returns.
Another factor in favor of a Roth IRA is that it is quite flexible as far as withdrawals. Certain provisions of the Roth allow contributors to receive distributions out of their principal without paying taxes. Married couples who are first time home-buyers have the ability to draw out up to $10,000 of their fund’s profits to use as a down payment on their new home, provided the rules of five years and 59 ½ are followed.
If for some reason a disbursement of all, or part of your investment is requested, be prepared to pay taxes on the amount withdrawn plus a 10% penalty.
Traditional IRA’s, as well as Roth IRA’s, permit annual contributions up to $5000 ($6000 at age 50) to be deducted from your tax obligations. For example, if your earnings were $25,000 for the year and you made contributions of $5000 to your Traditional IRA, you will pay taxes on only $20,000 of your income. Money in your IRA will earn interest until it is withdrawn at age 59 ½, at the earliest. It are not taxed until the disbursement process begins. Early withdrawals are subject to taxation as regular income, and a 10% penalty is also tacked on unless the money is used to pay for some qualified higher education expenses. Your income bracket now, and at retirement, will determine whether the Traditional IRA works in your best interest.
In most cases, a Roth is the better way to go, but before you attempt to convert your fund, there are considerations you must take into account. If you must use your currents IRA’s balance to pay the taxes that come into play in the transfer process, it may be an unwise decision. If your Traditional IRA is relatively new, the consequences may allow the transfer, but the move may place other restrictions on distributions. Your retirement planner is the person with whom you should discuss the pros and cons of converting.