Worried you won’t have enough retirement savings? Consider opening a Roth IRA, a type of retirement account that offers flexibility and financial advantages to middle-class Americans.
What is a Roth IRA?
IRA stands for “individual retirement account.” These savings instruments were born in the 1970s when the United States government realized that middle-class Americans needed additional vehicles beyond employer-sponsored pension plans and Social Security in order to plan long-term saving for major life expenses. Though there are several different types of IRAs designed for different purposes, including funding a child’s education or a developing a small business, the Roth IRA was developed specifically to help Americans save for a comfortable retirement. It is a lot like a savings account that you plan to invest in long-term for greater profit.
Roth IRA specifics
Roth IRAs are popular savings vehicles because they offer flexibility. Whereas contributions to a traditional IRA are taxed upon withdrawal, the money invested in a Roth IRA has already been taxed, so any return you earn won’t be taxed again as long as you wait until age 59 and a half to withdraw it. (Note that, after five years invested, you can choose to withdraw original Roth IRA contributions earlier than age 59 without penalty, though you cannot withdraw any additional profits made at that time.)
The other reason a Roth IRA is flexible is because it allows you to invest your retirement money in a number of common investments like stocks, bonds, mutual funds and certificates of deposit. You can choose how you wish to invest your money based on the methods you believe will be most profitable.
And, unlike a traditional IRA which typically requires that you take out your money starting at age 70, Roth IRAs don’t force you to make withdrawals. So if you don’t want to touch your funds until, say, age 80, then you’re free to make that decision. You can also leave a Roth IRA alone entirely and pass it on to an heir without penalty.
There are some limits to retirement savings with Roth IRAs. Here are the qualifications for this type of account:
• You must not make more than $110K annually if you’re single or more than $160K annually if you’re married.
• You must earn a minimum annual income equal to your Roth contributions. For example, if you earn only $5K a year, you can only contribute $5K to a Roth IRA.
• Roth IRAs are usually viewed as secondary retirement savings accounts, so there are limits to how much you can contribute at certain ages. In 2007, for example, a person under the age of 50 could contribute $4K annually to a Roth, and a person at least 50 years of age could contribute $5K. (The limit is higher for older people because they are closer to retirement and presumably need to start saving more aggressively, though limits change all the time. In 2012, a 35-year-old could contribute $6,500, for instance.) Check tax laws to determine current limits.
Important things to remember
You can select the financial institution, such as a bank or credit union, or the mutual fund company that will handle the money you contribute to a Roth IRA account. The deadline for contributing funds to a Roth IRA account is the tax deadline, April 15, of the following year. If you contribute more than IRA limits allow, you will have to withdraw excess funds prior to filing your taxes for the year. If you fail to do so, you’ll face a penalty.
Another thing to remember is that IRA contributions aren’t tax deductible. For some people, this is a drawback. However, there are no taxes taken on the earnings upon withdrawal later, as long as the Roth IRA — and its holder — are mature. This fact is a major advantage because, typically, the Roth IRA account’s value grows exponentially by the time the funds are needed for retirement.
Now that you know the advantages of the Roth IRA, start planning now to make your contributions this year! The earlier you start saving, the better off you’ll be financially later in life.
Photo Credit: Shutterstock / Cheryl Casey