Clearing Up Some Misconceptions about the Roth IRA


Retirement is something that most American feel that they don't need to think about until it comes time to think about it.

There are countless analysts who can give you countless suggestions on the best way to put your money away for retirement and most of them are probably pretty sound.

But, with every method for saving for retirement comes certain caveats that people can get burned by if they are not careful. It is not only important to save for retirement, it is also important to have a plan in place for saving for retirement and that is where many Americans fall short.

Roth IRAs are among the most popular retirement accounts available to Americans.

Retirement - photo courtesy of iStockThey essentially create a stream of income that has proven to be a powerful ally in the battle for comfortable retirement. And one of the best features of the Roth IRA is that it is tax-free. But while Roth IRAs are indeed a great way to save for retirement, there are things that those who choose a Roth need to keep in mind when deciding to move forward on them.

The first thing to keep in mind is that while a Roth IRA is indeed tax-free that doesn't mean that you don't pay taxes on that money.

The tax-free element comes once you actually retire and manifests in the form of tax-free withdrawals on the money in that account. Other accounts require a percentage of your earnings to be taken by taxes when you make withdrawals.

Earned income is a requirement for contributing to a Roth IRA.

Those in higher tax brackets are not allowed to contribute to a Roth IRA and contributions for a given tax year can be made as late as April 15th of the following year.

In order to receive the tax-free benefit of your Roth contributions, there are certain requirements that must be met:

  • The first is an age requirement that dictates that you must be over 59 years and 6 months old. If you try to draw on your contributions before you reach that age you incur a 10% penalty as well as certain additional taxes.
  • Also, you need to have had an open Roth account for a minimum of five years. In this regard, if a 58-year-old has a Roth IRA in 2013 he or she can still draw on the money in that account once they hit 59 years and 6 months without incurring a penalty. He or she will still have to wait five years, however, before enjoying tax-free withdrawals.
  • Finally, Roth IRAs have the added benefits of being able to be transferred to an heir. If a spouse inherits the account there are no minimum requirements for distribution.

However, if someone other than the spouse inherits the account, they must begin making withdrawals on it the year after the original owner dies. These are still tax-free and can be spread out over the beneficiary's lifetime.

This is an ideal scenario if the beneficiary is a young child since there is tremendous opportunity for the money in that account to grow significantly at a tax-free rate.

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Photo courtesy of iStock Photo.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Personal Finance , Retirement , Basics , Careers

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Joe Young

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