- What is a Roth IRA?
- What are the Roth IRA eligibility requirements and contribution limits?
- What are the investment options in a Roth IRA?
- When can investors withdraw money from a Roth IRA?
- How does a Roth IRA differ from a Traditional IRA?
- How can an investor choose between a Roth IRA and a Traditional IRA?
- Can an investor contribute to both Roth and Traditional IRAs?
- How can an investor set up a Roth IRA?
A Roth IRA is a tax-advantaged way to save for retirement. This type of individual retirement account allows your money to grow without taxation while it is in the account and—if certain conditions are met—allows you to withdraw any future earnings, in addition to your principal, from the account tax-free. Depending on your situation, these characteristics may make a Roth IRA an attractive vehicle for building retirement savings.
To make Roth IRA contributions:
- You or your spouse must have earned income, which must be greater than or equal to your contribution amount, for the year for which your contribution is made.
- Your contributions must be made by that year's tax filing deadline, excluding extensions.
- Your modified adjusted gross income (MAGI) must fall within certain limits, as shown below.
|Roth IRA Contribution Requirements for 2012*||Individuals||Married Couples Filing Jointly||Married Couples Filing Separately|
|Eligible to make a contribution up to the $5,000 annual limit ($6,000 if age 50 or over)||MAGI of less than $110,000||MAGI of less than $173,000||MAGI of $0|
|Eligible to make a partial contribution||MAGI of at least $110,000 but less than $125,000||MAGI of at least $173,000 but less than $183,000||MAGI of more than $0 but less than $10,000|
|Ineligible to make a contribution||MAGI of $125,000 or more||MAGI of $183,000 or more||MAGI of $10,000 or more|
The options are the same as those available in a Traditional IRA. Although the exact choices may vary between different financial institutions, you generally have broad flexibility in selecting investments within your IRA. These investments can include stocks, bonds, mutual funds, exchange-traded funds, and more.
You can withdraw your contributions (i.e., principal) without taxes or penalties at any time. When you take withdrawals from a Roth IRA, contributions are deemed to be withdrawn before any earnings on those contributions.
You may withdraw any earnings on your contributions without taxes and penalties once you reach age 59½ (or in the event of the account owner's death or disability) if the withdrawal is taken at least five years after the year of your initial contribution. Distributions of earnings that do not meet these criteria may be subject to ordinary income taxes and a 10% premature distribution penalty.
Please note that the withdrawal rules for Roth IRA contributions differ from the rules for amounts converted to a Roth IRA. Be sure to confer with a tax advisor if you are unsure how any distributions from your account will be treated.
Roth IRAs and Traditional IRAs are both tax-advantaged retirement accounts for individuals. The difference between them lies in the mechanics of that tax advantage. With a Traditional IRA, your contributions may be tax deductible, while distributions generally are taxed as ordinary income. Contributions to a Roth IRA, on the other hand, are not deductible, but, as discussed, Roth IRA distributions may be tax-free if certain conditions are met.
Another difference is that the rules for a Traditional IRA require investors to stop making contributions and begin taking required minimum distributions (RMDs) beginning with the year they reach age 70½ and each year thereafter. Owners of Roth IRAs, however, are not required to take distributions during their lifetime. In addition, unlike a Traditional IRA, owners can make contributions to Roth IRAs at any age as long as they meet the eligibility requirements.
If tax rates increase in the future, the potential value of tax-advantaged accounts such as IRAs becomes greater. Although a Traditional IRA funded by tax-deductible contributions may have the upfront advantage of reducing income tax at the time of contribution, Roth IRAs can result in higher potential after-tax retirement income than Traditional IRAs in certain situations due to their tax-free treatment of qualified withdrawals and the fact that RMDs are not necessary.
When planning for the future, investors should keep in mind that current tax laws and tax rates could change. Given that uncertainty, investors should consider the following general guidelines:
- The Roth IRA may be a good option if you expect your tax bracket in retirement to be the same or higher than your tax bracket during your working years.
- A Roth IRA may be a good idea if you have many years for your investments to grow before beginning withdrawals.
- Even if you are close to retirement, you should consider a Roth IRA unless your tax bracket is expected to drop significantly in retirement and you have a short time before beginning withdrawals.
Of course, many factors can influence the amount of after-tax income you have in retirement. A financial or tax advisor can provide more guidance on which accounts are appropriate for your situation. In addition, once you've made a decision, it's a good idea to review your retirement savings strategy periodically to make sure it continues to meet your needs.
Yes, as long as the combined contributions to the Roth and Traditional IRAs do not exceed the $5,000 ($6,000 if over age 50) annual contribution limit. In fact, diversifying your retirement assets by investing in a combination of taxable, taxdeferred (Traditional IRA), and tax-free (Roth IRA) products can provide flexibility in retirement and help you weather the uncertainty of future tax rates.
Roth IRAs, like Traditional IRAs, can be set up with financial institutions such as mutual fund companies and banks.
Additional information on IRAs and setting up an account can be found at the T. Rowe Price IRA website, troweprice.com/ira, or by calling 1-800-IRA-5000. The website also includes a selection tool designed to help investors determine the type of IRA that best fits their situation. You may also find more information about IRAs and current tax laws affecting them in IRS Publication 590, which is available online at irs.gov.
T. Rowe Price (including T. Rowe Price Group, Inc., and its affiliates) and its associates do not provide legal or tax advice. Any tax-related discussion contained in this document, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this article.