Understanding Your Roth IRA: What You Need to Know

by FinancialTips4U

People saving for retirement often turn to individual retirement accounts (IRAs). In addition, Roth IRAs are popular with investors looking to retain control over their money.

When people begin to see the importance of saving for retirement, they often turn to individual retirement accounts (IRAs) for an effective and rewarding investment strategy. With fewer limitations and tax benefits during retirement, Roth IRAs are especially popular with investors looking to retain control over their money. To determine whether or not a Roth IRA is the right investment for you, it's important to understand how the account differs from a traditional IRA. Consider the following rules, restrictions and account terms you'll encounter.

Introduction to the Roth IRA and Traditional IRA

Traditional IRAs and Roth IRAs share plenty of similarities, so you'll enjoy great benefits with either type of account. You'll earn a favorable interest rate on the entire balance of your account for the duration of your investment. Additionally, you'll receive tax benefits for investing in an IRA, though the benefits differ depending on the type of IRA you have. Any portion of income that you invest in a traditional IRA is tax-deductible, which allows you to pay less on your taxes during the contribution period. Of course, you will pay taxes on any amount you withdraw when you reach retirement age. Roth IRAs allow you to make tax-free withdrawals from your account during retirement, though you'll be taxed on your full income during the earlier part of your life. People who plan to be in higher tax brackets at retirement often opt for Roth IRAs, as they can ultimately save more through tax-free withdrawals.

Distribution Period and Withdrawals

Whether you choose a traditional or a Roth IRA, you'll have to wait until the age of 59 1/2 to make withdrawals without paying penalties. Early withdrawals typically carry steep penalties, so it's important to plan ahead for other sources of income until you can take money from the IRA. You aren't required to take distributions from your account at age 59 1/2, though you will incur penalties if you have a traditional IRA and fail to withdraw funds before age 70 1/2. Roth IRAs typically do not require you to withdraw money at any point, and you can also continue to contribute money throughout the duration of your investment.

Rules for Contributions

Both Roth and traditional IRAs place similar limitations on contributions. You're generally allowed to contribute up to 5,000 dollars per year, though there are some cases in which you can contribute additional funds. Some investors choose to keep one of each type of account in order to receive some tax benefits upfront and some during retirement. This investment strategy is an effective way to split your tax benefits, but you will typically still be constrained by the contribution limit of 5,000 dollars. You could also incur additional fees by maintaining multiple IRA accounts, so it's important to check with your bank. If you're looking at a Roth IRA from Discover or another financial service provider, find out what kind of limitations are placed on the account.

Evaluating Your Investment Needs

The best way to determine which IRA is right for you is to figure out when you want to receive your tax benefits. If you're interested in saving in the short-term, a traditional IRA that allows you to reduce your taxable income might be the best choice. However, if you think your income will place you in a higher tax bracket at retirement, you'll benefit more from the Roth IRA's tax-free withdrawals.

Retirement Plans & Investments : Compare a Roth IRA & a Traditional IRA

Would you be more interested in a traditional IRA or ROTH IRA?

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N. Farley is a freelance writer with a wide range of publications to her credit. She specializes in articles on finance, search engine optimization and Internet marketing. Nicole has a background in management, journalism and English literature and has been writing full-time since 2010.

Updated: 01/02/2012, FinancialTips4U
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