Everything You Need to Know about a Roth IRA

There’s something so profoundly confusing about retirement plans, including the Roth IRA. You know you can open one, contribute to it and see some sort of tax write-off as a result, but that doesn’t exactly make it understandable. In fact, I’m a firm believer that if investments and Roth IRAs and other retirement accounts were easier to understand and less complicated to navigate, more people would be willing to invest their money and save for retirement. But, that’s just me. I like things spelled out for me as if I’m stupid so that I am sure to understand what it is I’m reading, looking at and attempting to comprehend. Too many big words about something already uninteresting and kind of boring, well, I let my inner clueless take over and I mentally check myself right on out.

Roth IRAs aren’t that complicated once you get to know them a bit. They’re retirement accounts that burst onto the scene some time ago (1974 to be precise) and they’re allowing us to get tax write-offs every year. That’s all you need to know – kidding, there is a lot more you need to know. The point of the Roth IRA, and all retirement accounts to be honest, is to allow you to save for retirement without having to pay taxes on the interest you earn each year. After all, who wants to put money away for a later date and then turn around and pay taxes on it each and every year even though you’re not actually using it at the moment? That’s right; no one.

Back in 1974 with the Roth IRA became a thing, people loved it from the start. It was back then that you could contribute up to $2000 per year from your income prior to taxes, save it, earn interest on it and then pay taxes on that income when you retire. It was a huge hit, especially when American workers found out that they could deduct this from their income taxes every single year without question. People loved them, they used them and they got to see their retirement nest eggs turn into something quite substantial and exciting. That’s when people’s retirement accounts became more impressive than ever. The problem with this account is that it turns out that the men and women on the low end of the totem pole – the ones in lower tax brackets, end up paying more in taxes when they retire because the higher-paid guy in a higher tax bracket ends up getting a much larger tax break on his Roth IRA deduction than the low-end man. That’s when the government began changing things and making it possible for you to save money and forgo some of your taxes. It’s a bit complicated the changes that were made, so try to keep up as I explain it the best that I can so that anyone over the age of 3 will understand – because that’s how I like to hear things.

So what else do you need to know about the Roth IRA? Read on to find out.

Who is Eligible to Open a Roth IRA Account?

If you work, you can open a Roth IRA. There are no stipulations other than being an employed person with income and a job. You have those, you can open up this kind of account to begin saving for your own retirement. It’s really that simple.

How Much can you Contribute?

This is where some people become most confused. The contribution limits change regularly – well, often enough – and it tends to throw people off balance quite a bit. For example, if you are a married taxpayer filing jointly or you are a widowed taxpayer, you can contribute as much as $5000 per year. However, that’s only for taxpayers who earn less than $169,000 per year. If you are a taxpayer filing as married or a widower and you make more than $179,000 per year, you cannot contribute to a Roth IRA. If you make between $169,000 and $179,000 per year, you can contribute, but you may not contribute $5000 per year. Does that make sense?

If you are a single taxpayer, you file as Head of Household or you file as a married couple filing separately, the rules change for you. You are permitted to contribute up to $5000 per year, but only if you make less than $107,000 per year. If you make more than $122,000 per year, you cannot contribute at all. If you make somewhere in between those two limits, you can contribute, but not up to $5000.

Now we get into age just because we want to confuse you just a bit more. If you are a taxpayer over the age of 50, it doesn’t matter how much you make; you can contribute as much as $6000 per year to your Roth IRA.

Advantages of a Roth IRA for Taxpayers

Now you want to know whether or not this is the right type of retirement account for you to open, and we have the answers for you. If you are looking for the advantages of this type of account, they are right here. If you can keep from removing any of the funds from this account until you are at least 59 and-a-half, you never have to pay taxes on the money you withdraw. Yes, you read that correctly. You never have to pay taxes on this money. The other good news is this; if you need that money prior to turning 59 and-a-half, you can pull it out and start using it without paying a penalty. Why? Because you already paid taxes on it when you put it in there.

Just another piece of information that keeps Roth IRA savers happy is this one; if you do not own a home for at least two years, you can take as much as $10,000 from your account without paying a penalty so that you can use it for a down payment on a new house. It’s not enough of a down payment, but every little bit helps. Especially when you are not paying taxes on it and it’s your money to begin with.

Furthermore, a Roth IRA allows you to contribute to other retirement plans as well and still take the tax deduction. This includes your typical 401k, 403b and other qualified education savings plans. A Traditional IRA does not allow this, and the IRS will not allow you to deduct your contributions to this account another others. This is the kind of tax advantage that means a lot to you when it comes to filing your return.

Finally, there is no minimum withdrawal amount. Since most other retirement accounts force you to take some sort of withdrawal so that the IRS can collect their tax money, most people prefer to take this kind of account into consideration since that is not a requirement. You can take it, leave it and do with it what you see fit.

The Disadvantages of a Roth IRA for Taxpayers

Of course, nothing comes without at least one disadvantage, this particular retirement savings plan included.

You have to pay taxes on these contributions. The good news, however, is that it makes very little difference to you right now – unless you are in a very high tax bracket. What this means is that later on, you will not pay taxes on your money when you are on what is likely a much tighter budget. Not having to pay penalties in the future is nice, but sometimes you don’t want to pay taxes at the moment on money you are not even using.

This is a bit morbid, but it is a disadvantage. If you do not live until you retire and you do not get to use your Roth IRA, you never realize the actual tax benefits of this account. However, you will be dead so you probably won’t care much about that in the first place. Some consider it a better idea to just put their money into a traditional savings account since it seems to be essentially the same thing, but it all depends on what you see fit in terms of your retirement accounts and what you want out of them.

Losing the tax benefits that you might get from a Traditional IRA is a bit too much for many taxpayers. However, there are always other options to consider. You have to consider where you are financially, what you can afford to contribute on an annual basis and how much money you have to begin with. What kind of taxes are you paying right now? Are you paying taxes that are higher or lower? What will benefit you the most in terms of retirement savings? These are amazing questions to speak with an investment advisor or CPA about, since they are both well-versed in their job, the laws of the IRS and what might work best for your particular financial standpoint.

Which is Better?

When it comes to comparing a Traditional and a Roth IRA, it’s almost like comparing apples and oranges. They both have their good points and their less than ideal points, and they both look different. However, your taste might differ from that of others, which might mean that it’s easier for you to decide that you want something quite specific. While other taxpayers might hem and haw over which IRA savings account to choose, the answer might seem very obvious to you.

If you cannot decide and you want to take advantage of both, why not diversify your portfolio? Many tax experts suggest that those who don’t make much now use a Roth IRA account so that they aren’t paying much in taxes. Once your income increases, it’s recommended that you switch over to a Traditional IRA. Others recommend that taxpayers begin using both accounts. You can do that, though some taxpayers are unsure whether or not this is permitted; it is.

Try not to Panic

As we discuss all the things that you should know about a Roth IRA, we have to remind you that it’s not a requirement to contribute to an account such as this. However, it’s a good idea to do it. Why not, when you can pay taxes on it now and then live tax free on this money when you retire? Some might call this a financial gift from the Heavens when it comes time to retire. And even if you do decide you want to utilize the benefits of a Roth IRA, you are not required to contribute the full $5000 (or whatever amount you happen to qualify for). You can contribute what you can afford. This means if you can only contribute $200 per month, you can do that without an issue.

Let’s do a little bit of math. If you contribute $200 per month for 25 years and you have a 4% interest rate as your earnings each year, you will have more than $103,000 to use when you retire – and all of that money is then tax-free. It’s almost too good to be true, which is why so many people choose to open an account such as this. All you have to do is look to the future. It’s a concept that is difficult for many taxpayers, especially those that are still young. They are more of a live for the moment type, figuring they have plenty of time to worry about their retirement as they get older.

The truth is that retirement is something we have to start worrying about as soon as we begin our professional careers. You are never too young to contribute to a retirement account, because you will need that money if you ever hope to leave your job and not work again. This means that contributing now and understanding that the taxes you are paying on a Roth IRA today are worth it when you consider living on that money tax free in the future is imperative.

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