Roth IRA and Retirement Planning

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Individual Retirement Account (IRA) is called traditional IRA while the Roth IRA is named after Senator William Roth of Delaware who dies in 2003. He was architect of this new type of IRA. The traditional IRA was created in 1975 to help compensate Americans who did not have employee-sponsored retirement plans. In the 1990s the U.S. government expanded on the traditional IRA to offer more flexibility to IRA contributors. The Roth IRA was born as a result of the Taxpayer Relief Act of 1997.

Common Types of IRAs

Traditional IRA allows contributions to be tax-deductible. Contributors must start withdrawing funds by age 70 ½. The funds withdrawn will be taxed as ordinary income.

Roth IRA allows the contributor to withdraw funds tax-free and does not require that funds ever be withdrawn.

SEP (Simplified Employee Pension) IRA assists small- business owners in providing retirement plans for their employees.

v SIMPLE (savings incentive match plans) IRA allows small business owners and those who are self-employed to have a matching contribution plan not unlike a 401(k) plan.

v Education IRA helps pay for higher education.

How Roth IRA Works:

Roth IRAs include many of the benefits offered in all of the varying types of individual retirement accounts mentioned above. Here are some terms used in setting up a Roth IRA:

v Contribution means the amount of money you personally invest in a Roth IRA.

v Earnings the contributor earns on his/her investments.

v Heir is the person designated in your will to receive property.

v Profit is the return you make on your investment.

Roth IRA is like a savings account but money invested in it should generate a higher return that is greater than you earn in a savings account. Moreover, you pay taxes on the earnings from your deposits in the saving account all your life. In case of a Roth IRA the profit gets reinvested in the Roth IRA until the date of its maturity. Since you invest your money into a Roth IRA after taxes, you do not pay taxes on the earnings upon withdrawal of the funds at or after the maturity date. In other types of IRAs, 401(k), or 403(b) you pay taxes when you withdraw funds. Having met certain criteria the contributor can be withdrawn from it prior to maturity without being penalized.

Qualification for Roth IRA:

v You can make non tax deductible annual contributions of up to $4,000 ($5,000 if age 50 or over) to a Roth IRA. You can continue to make non tax deductible contributions to a Roth IRA after age 70½ and there are no minimum distribution requirements.

v The Roth IRA phases out for singles with Modified Adjusted Gross Income of between $95,000 and $110,000, and couples with Modified Adjusted Gross Income of between $150,000 and $160,000.

v You can convert or "roll over" your existing IRA into a Roth IRA account but must pay income tax when you convert it, but lawmakers waived the usual 10 percent penalty tax for early withdrawals from an IRA. A separate Modified Adjusted Gross Income limit of $100,000 applies to people who roll over their regular IRA to a Roth IRA.

Roth IRA Distributions:

v Distributions from a Roth IRA are qualified and thus tax free if they are made after the five (5) year holding period and for any of the following reasons: you are 59½ or older; your are disabled; you use the distribution to pay for up to $10,000 of qualifying first time home buyer expenses; or your are the beneficiary receiving distributions following the death of the Roth IRA account owner.

v Regardless of the five (5) year tax rule if Roth IRA distributions do not exceed contributions they are not taxable.

Some Drawback to Consider:

v There are no current tax-saving for your contributions. You are taking a chance for future benefits when tax laws can change and so your tax bracket.

There is always has a “5 year rule” attached to it. You should consider whether or not your money will be in a Roth-type account for at least 5 years. To complicate matters, your money may lose its 5+ year “aging” if you roll it out of a Roth 401k and into a brand new Roth IRA.

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