Your Guide to Understanding the Roth IRA

A Roth Individual Retirement Account can be an excellent retirement savings vehicle, particularly for younger workers, and for those who fear they will be in a higher tax rate in retirement. A Roth IRA provides tax-free withdrawals in retirement, and those tax-free withdrawals can be very valuable.

Not Tax Deductible
When the IRA was first introduced, the only version available was a tax-deductible investment option. Workers could set money aside to invest in their IRAs, and then take a tax deduction when they filed their taxes.

This traditional IRA is still available, and it is a good option for workers who need the extra tax deduction and the lower tax liability it provides. With a Roth IRA, there is no up-front tax deduction, meaning that the amount you put in has no bearing on your taxable income or your tax liability.

Tax-Free Withdrawals
The major advantage of a Roth over a traditional IRA is that workers can withdraw the money from the plan tax-free in retirement. This tax-free treatment can be a real advantage, especially if tax rates are higher in the future than they are now. Taxpayers who expect to be in a higher tax bracket when they retire can give up the current tax deduction for the promise of tax-free withdrawals later on. Each worker needs to weigh the pros and cons carefully to decide if tax-free future withdrawals or up-front tax deductions provide the better deal.

Contribution Limits
The Internal Revenue Service establishes the contribution limits for Roth IRA accounts. The agency then reviews those limits annually and determines whether or not a change is warranted. For both the 2010 and 2011 tax years, the annual contribution limit for the Roth IRA is $5,000 per taxpayer for those 49 years of age and under.

Taxpayers who are at least 50 years of age may contribute an extra $1,000, for a total of $6,000. These annual limits are reviewed by the IRS, so it is a good idea to check with your accountant before you plan your future Roth IRA contributions.

Roth IRA Income Limits
Not all taxpayers can contribute to a Roth IRA. For the tax year 2010, single taxpayers who earn at least $105,000 have their Roth IRA contributions phased out. Single taxpayers earning $120,000 or more cannot contribute to a Roth IRA. For married taxpayers, the phase-out starts at $167,000 and the contribution disappears completely at $177,000 in income.

Investment Options
As with a traditional IRA, you have a number of choices for investing your Roth IRA money. The Roth IRA is simply the investment vehicle – you can choose a number of investments within that framework, including individual stocks, stock mutual funds, bonds, bond funds and fixed income investments like certificates of deposit and money market accounts.

If you plan to hold individual stocks within your Roth IRA, you might want to choose a discount broker to administer your plan. This arrangement will give you access to the trading platform the broker provides, as well as the ability to buy and sell stocks within the plan as you wish.

If you prefer to use mutual funds as the basis of your Roth IRA, you can open an account with a low cost mutual fund family. This can help you keep your costs under control and let you make the most of your money.

But no matter what type of investments you choose, opening a Roth IRA can have a profound impact on your retirement portfolio and your future tax situation. Few investments provide the opportunity to accumulate money tax-free, but a Roth IRA does just that.

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