March 27th, 2012
What Is a Roth IRA?
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Guess what? I’ve got a fever. And the only prescription… is more Roth IRA education!
When Good Financial Cents blogger Jeff Rose asked a class of graduating college seniors if they had ever heard of a Roth IRA, out of the 50 class participants, no one raised their hand. (To be frank, I wouldn’t have been raising my hand in my day, either.) What did Jeff do? He started a movement among personal finance bloggers asking them to write about Roth IRAs on Tuesday, March 27. It’s called, quite appropriately, the Roth IRA Movement.
So here we are, about to cover some investing knowledge ground. Let’s start with the basics.
What is a Roth IRA?
First of all, an IRA is a retirement savings account, also known as an “individual retirement arrangement,” in which a consumer can invest in stocks, bonds, funds and other financial assets. These accounts can be opened regardless of whether or not you already have a 401(k). There are several types of IRAs; Traditional and Roth are two of the most commonly referenced.
At the least, a Roth IRA is another savings account specifically for long-term savings. At best, it’s a powerful tool for future tax-free retirement savings. You can start contributing to a Roth IRA at age 18, and your contributions will max out at $5,000 per year.
Who is it for?
A Roth IRA allows the flexibility of withdrawing penalty- and tax-free after five years, but it’s not for everyone. For instance, if you’ll be tempted to dip into your retirement savings, you may not want to put it all into your Roth IRA. Your Roth IRA should be a long-term savings solution, not an emergency fund.
In contrast, a Roth IRA might be right for you if you’re interested in saving for your heirs. You can pass down your Roth IRA to an heir, and he or she won’t have to worry about paying taxes on it.
What makes it different from a Traditional IRA?
A Traditional IRA is a retirement account that allows you to invest pretax income. There are several key differences between a Traditional IRA and a Roth IRA:
- A Traditional IRA is tax-deductible and tax-deferred, meaning you’ll only be charged income taxes on your contributions when you begin withdrawing them for retirement. A Roth is tax-exempt, meaning you’ll pay taxes on your contributions as they’re made and in your retirement, you’ll be able to make withdrawals income tax free.
- With a Traditional IRA, you can begin making withdrawals penalty-free at the age of 59.5. However, you’re required to begin making withdrawals from the account after April 1 of the year you turn 70.5. With a Roth IRA, you can pass your savings on to your heirs (which they’ll receive tax-exempt), or you can begin making withdrawals at age 59.5.
- If you wish to withdraw from your Traditional IRA before the age of 59.5, you’ll pay a penalty fee, unless you’re withdrawing for a first-home purchase or to pay for higher education. In contrast, direct contributions to a Roth IRA can be withdrawn at any time, after a five-year seasoning period.
How do I get started?
There are lots of options, but instead of writing up an extensive list, I’ll direct you to Good Financial Cents’ article, Best Places to Open a Roth IRA.
Keep in mind that your Roth IRA shouldn’t take the place of your employer-matched 401(k). If your company offers a matching plan, take it! Your savings will grow faster with both you and your employer contributing.
Still don’t know which retirement option to choose? Check out our CuteGeek article to help you pick a retirement plan.
Bottom Line: Retirement might seem like a long time from now for some of us, but don’t let that stop you from starting to save today. To help start your nest egg (or something else about actually starting fund, not just motivating), check out this contest to win $5,000 to fund your IRA. Just head over to Good Financial Cents to get the details.
Have a Karmic Day!
Bethy Hardeman, Social Media Maven