The Roth IRA (Individual Retirement Account) is a retirement savings account created by the Taxpayer Relief Act of 1997. Named after Delaware Senator William V. Roth, Jr., the Roth IRA allows individuals to accumulate capital tax-free, provided they meet certain conditions. Contributions made to a Roth IRA are not tax-deductible, but withdrawals of both principal and earnings may be tax-free under qualifying circumstances.
Contribution Limits and Catch-Up Contributions
For 2011, individuals can contribute up to $5,000 a year to a Roth IRA. Those aged 50 and over are eligible for additional “catch-up contributions” of up to $1,000, allowing them to invest a total of $6,000. These limits are periodically adjusted for inflation.
Example
Assume an individual aged 52 contributes $6,000 annually for 15 years to their Roth IRA. Assuming an average annual investment return of 6%, the Roth IRA could grow to approximately $144,500 by the time they reach age 67, all of which can be withdrawn tax-free under qualifying conditions.
Tax Benefits and Withdrawal Rules
Withdrawal Rules
- Age Requirement: Withdrawals can be made totally tax-free after age 59½.
- Holding Period: The assets must have been held in the Roth IRA for at least five years from the first contribution.
Tax Implications
- Principal Contributions: Can be withdrawn tax-free and penalty-free at any time.
- Earnings: Withdrawn tax-free if the withdrawal is qualified (i.e., age 59½ and after the five-year holding period).
Example of Qualified Distribution
A 60-year-old who opened a Roth IRA at age 55 can withdraw both their contributions and earnings tax-free, provided the account has met the five-year requirement.
Estate Planning and Inheritance
If the account holder dies before making withdrawals, the Roth IRA proceeds pass to their beneficiaries tax-free. Unlike Traditional IRAs, Roth IRA participants are not required to take distributions starting at age 70½ and can continue to make contributions even after this age.
Example of Inheritance
An account holder who dies at 75 with a Roth IRA can leave the account to their children. The heirs inherit the account tax-free and can manage distributions according to IRS rules for inherited IRAs.
Differences from Traditional IRAs
- Contributions: No tax deductions for contributions to Roth IRAs, unlike Traditional IRAs.
- Distributions: No required minimum distributions (RMDs).
- Eligibility: Income limits for contributors may apply.
Related Terms
- Traditional IRA: A retirement account with tax-deductible contributions and taxable distributions.
- Catch-Up Contribution: Additional contribution limits for individuals aged 50 and over.
FAQs
What is the income limit for contributing to a Roth IRA?
Can I contribute to both a Roth IRA and a Traditional IRA in the same year?
Are Roth IRA contributions subject to income tax?
References
- IRS Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs).
- IRS Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).
- “Investopedia,” Roth IRA: Definition, Advantages, and Disadvantages.
- “Internal Revenue Service,” Roth IRAs.
Summary
A Roth IRA offers a powerful way to save for retirement with the benefit of tax-free growth and withdrawals. Created by the Taxpayer Relief Act of 1997, it allows for flexible contribution limits and no required minimum distributions, making it an attractive option for long-term retirement planning.
