Roth IRA 2010, Basics
The Roth IRA legislation which passed on January 1, 1998 as a result of the Taxpayer Relief Act of 1997 created one of my favorite savings tools!
The Roth IRA provides no tax-deferral for contributions, but as long as you meet the criteria, all earnings are tax free when you or your beneficiary withdraw them. Other benefits include avoiding the early distribution penalty on certain withdrawals, and eliminating the need to take minimum distributions after age 70½. The Roth is a personal favorite mainly because I know that whatever is in my Roth IRA is mine. Most people forget that when they go to take a distribution from a traditional IRA they have to pay taxes on the amount. However, there are cases where the Traditional IRA makes more sense.
Pros and Cons of The Roth IRA
The chief advantage of the Roth IRA in 2010 is obvious: the ability to have investment earnings completely escape taxation. On the flip side and as I mentioned above, you don’t get the benefit of tax deferral.
So which is more important? It depends on your personal situation, and also on what assumptions you want to make about your future income. How long before you withdraw money from your IRA? What will your tax bracket be then? What earnings can you anticipate in the interim? Also keep in mind that many people are living well beyond the traditional retirement age of 65; so, in many cases their income at retirement is as high or higher than before the age of retirement.
In my personal opinion, most people are better off in the Roth IRA. The primary reason is that the Roth IRA is ultimately going to be larger than a regular IRA because it holds after-tax dollars. If you can take advantage of this feature of the Roth IRA by maximizing your contributions (that’s the key factor) you’ll add greater tax leverage to your retirement savings and you should have more income when you retire.
There are two other significant advantages to the Roth IRA. One is that the minimum distribution rules don’t apply. If you’re able to live on other resources after retirement, you don’t have to draw on your Roth IRA at age 70½. That simply means your earnings continue to grow tax-free. The other big advantage is the ability to take certain early distributions without paying the early distribution penalty. I like this mainly because if you have to tap into your Roth IRA for an emergency, you will avoid the early withdrawal penalty. In short, the Roth IRA in 2010 is much more liquid. I say “Roth IRA in 2010” because we never know if the rules will change.
Eligibility
You can establish a Roth IRA by making a regular contribution to a Roth IRA or by converting a traditional IRA to a Roth IRA.
You may be eligible to make a regular contribution to a Roth IRA even if you participate in a retirement plan maintained by your employer. For the contribution limits of a Roth IRA in 2010, click ROTH CONTRIBUTION LIMITS
You can also convert your regular IRA to a Roth IRA if (a) your modified adjusted gross income is $100,000 or less, and (b) you’re single or file jointly with your spouse. In 2010, these limitations on Roth conversions disappeared and you can find more about that clicking on CONVERTING A TRADITIONAL IRA TO A ROTH IRA IN 2010.
Distributions
Distributions from Roth IRAs are tax-free until you’ve withdrawn all your regular contributions. After that you’ll withdraw your conversion contributions, if any. When you’ve withdrawn all your contributions (regular and conversion), any subsequent withdrawals come from earnings. Withdrawals of earnings are tax-free if you’re over age 59½ and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions) they’re taxable and potentially subject to the early withdrawal penalty.
Summary
The Roth IRA in 2010 has a couple new benefits that allow more people to take advantage of. Remember one of the 7 Wonders of the World is Compounding Interest. The Roth IRA allows you to compound interest and capital gains tax free. If you haven’t already, take advantage of the Roth IRA today.
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