A Roth IRA (Individual Retirement Account) is a savings plan that allows you to make pre-taxed contributions to a retirement plan. The earnings are tax-free, although Roth IRA contributions are non-deductible. Come retirement, qualified withdrawals are also tax-free.
In contrast, a traditional IRA lets you contribute tax-deferred funds. The money grows tax-free and contributions are deductible. However, when funds are withdrawn after the traditional IRA matures, both the initial contributions and earnings are subject to federal income tax. Similarly, a 401(k) is a plan where employers match employee contributions and invest the money for retirement. Both the contributions and earnings are taxed after the 401(k) matures.
A Roth IRA account is the best choice if you plan on being wealthier when you retire than you are today, because the funds you contribute are taxed based on your current earnings.
Once you ask the right questions, and determine that a Roth IRA is for you, go for it. The sooner you invest in a retirement plan the better. Just remember to consider the following:
- Decide if a Roth IRA furthers your retirement goals.
- Determine which financial institution offers the best plan.
- Sign up and start making Roth IRA contributions.
Action Steps
The best contacts and resources to help you get it done
Check out financial institutions that offer Roth IRA plans
Although banks often accept small accounts, they may not offer as much flexibility as a mutual fund. Mutual funds provide wider investment opportunities to diversify your portfolio. Brokerage firms are another option: they allow you to design your own portfolio with a combination of mutual fund shares and individual stocks.
I recommend: Review the options offered by
Scottrade,
Fidelity,
Charles Schwab & Co. or
E*Trade, all of which offer Roth IRAs as part of a diverse investment strategy. Ideally, any relationship you make now will take you right into retirement.
Get the facts on a Roth IRA's terms and conditions
The more Roth IRA information you have, the better. Find out about any fees or required minimum balances. You will also need to know whether or not there is a maximum annual contribution, any Roth IRA rates, and requirements and penalties associated with a Roth IRA conversion.
I recommend: Compile a list of questions to ask. Check out
Investopedia to familiarize yourself with common Roth IRA information and criteria.
Make your Roth IRA investment distributions tax-free
Understanding the difference between qualified and non-qualified distributions will save you from paying taxes. A distribution is considered qualified only when it adheres to certain criteria, including age of the account holder and the amount of assets distributed. A non-qualified distribution is one made outside of these specified criteria.
I recommend: Go to
Fairmark for a breakdown on qualified versus non-qualified distributions before opening a Roth IRA.
Tips & Tactics
Helpful advice for making the most of this Guide
- Unlike other tax advantaged retirement accounts, owners of Roth IRAs are not required to withdraw Minimum Required Distributions (MRD) each year after they turn 70 1/2. There is one exception, however: if the Roth IRA account originated from a Traditional IRA. Additionally, if the beneficiary is not a spouse of the owner, then the Roth IRA will be subject to a 50% penalty if the distributions go unmade.
The official source of Roth IRAs is the Roth IRAs page at Business.com
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