What Is a Roth IRA?


One kind of investment you may have heard of is a Roth IRA. However, you may not be completely clear on what a Roth IRA exactly is. Here is some information to help you understand what a Roth IRA actually is and whether or not making this kind of investment would be right for you.

First, you should know that IRA stands for individual retirement account. This kind of retirement account is very distinct from other forms of retirement in the United States. IRAs are for one given certain special tax benefits. What kinds of benefits are given depend on what kind of IRA is used.

A Roth IRA gains its tax benefits from the fact that taxes are only applied to the funds in the account as they are added into the IRA. As the funds with in the account develop, no tax is applied to them. Better yet, when the funds are removed, the owner of the account will have to pay no taxes on the funds he or she takes out of the account.

One of the main elements of a Roth IRA is the fact that the funds put into the account will be invested with the hope of producing a profit. Things that the funds in a Roth IRA are likely to be invested in include mutual funds as well as the stock market.

One possible downside of investing in a Roth IRA is how taxes are applied when funds are first deposited into the account. The taxes applied to these funds will be based on the tax bracket that the investor currently occupies. This could be a significant negative for certain groups of people who expect to be in a lower tax bracket when they retire. This is not the case with a normal IRA. With the more traditional version of the IRA, this is less of a problem due to the fact that the money is taxed when you take it out of the account.

Another downside is that a person may have to pay certain penalties if he or she removes money from the IRA too early. These penalties can be quite expensive and include the federal tax rate in addition to a ten percent fee. Thankfully, there are certain exceptions one can use to avoid such penalties. One such exception is when the funds are use to make a down payment on a home. Another exception is for funds that are used to pay for a child’s college tuition. Penalties can also be avoided when a person simply removes as much or less money than he or she originally put into the IRA.

There are also other specific limitations placed on Roth IRAs. For example, they are designed for people who remain in a specific range of income. That range is partly determined by marital status. If that person’s income falls below a certain predetermined level, the amount of money that person is allowed to contribute into the IRA lowers as well. If the opposite happens and a person’s income rises significantly, that person may be restricted from placing any more money into the account if his or her income exceeds a certain level.

Due to the very specific nature of how Roth IRAs operate, they should only be used by specific groups of people. The group likely to benefit from using Roth IRAs the most are individuals who expect to retire at a higher income bracket than they currently inhabit. This is due to the fact that the funds are taxed when they are placed into the account and not at the time they are taken out like more traditional IRAs.

For example, a person’s income tax bracket may only require that person to pay twenty percent taxes on the funds when they are deposited into the IRA. However, that person’s income may rise over the life of the Roth IRA to put that person in a new tax bracket. This new tax bracket may require him or her to pay thirty five percent in taxes on the funds if those taxes were applied at the time the funds were removed. This way the owner of a Roth IRA can save a lot of money compared to what would be possible with a regular IRA.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

Email  • Google + • Twitter

Comments are closed.