Sunday, February 16, 2014

How does a Roth IRA work?

We explain the common question that we are asked a lot : How does a Roth IRA work?

When it comes to retirement, many people often think it is far much early to start planning for it. But the truth is quite different, you never realize how fast time flies. For this reason, you should start planning for your retirement as early as possible. This definitely means that you must find out a retirement plan that works for you.  Roth IRA is a special type of retirement plan that your funds grow tax-free. Roth IRA  allows you to invest post-taxed income for your retirement. In this article I’ll address the question, “How does a Roth IRA work?” In general this article looks at the merits, the risks and rules associated with investing your retirement funds in a Roth IRA.

What is a Roth IRA?

Roth IRA, just like the Traditional IRA, is an individual retirement account but it has a special treatment of taxes very distinct from other retirement plans, often referred to as the Roth treatment. The Roth treatment involves funding your retirement with post-taxed income, thus you don’t take deductions on Roth IRA contributions. These contributions can be invested in a number of investments which include bonds, mutual funds, index funds, money markets, real estate and many more.  But what makes the Roth treatment so special is the fact that the returns on these investments are not taxed.

When saving for retirement, you create a pool of funds that you will access at retirement. However, these funds might never be enough for you if you lived longer or perhaps they can not offer you the lifestyle you were used to. Roth IRA addresses this problem by allowing you to invest your retirement funds in a variety of investment so that your funds can grow. The contributions together with the generated earnings can later be withdrawn and used for the purposes of funding college expenses, first home purchase or even meet medical expenses.

The Differences between Roth IRA and Traditional IRA

The are many differences between Roth IRA and traditional IRA, but the most outstanding one is the fact that  Roth IRA is funded by non-deductible contributions while the traditional IRA allows you to take tax deductions.  Since the tax has already been paid on the contributions, Roth IRA allows you to access your funds without taxes or penalties at any time provided that you opened the accounts for have been in the account for the past five years. You can also withdraw the earnings on these contributions without paying taxes provided that you are 59 ½ or more.  But as for traditional IRA, taxes are imposed on all the transactions since the tax was differed until withdrawal or retirement.

The Reason to Chose Roth IRA and How does Roth IRA  work for you?

After retirement, your major worry should be how to spend the free time. This is only possible if you put your investment funds in a safe nest over the years. If you chose Roth IRA, you stand to gain from compounding interest. As a retirement tool, Roth IRA allows to choose your investment portfolio such that you diversify your investment in a wide range of investment fields. There is a long list of benefits associated with Roth IRA which has become a popular choice to many people.

Benefits of Roth IRA

There are a number of reasons why you should chose Roth IRA some of which are discussed below.

The Roth IRA contributions can be withdrawn at any time provided that your account was opened at least five years ago. The withdrawal, unlike in other plans, is free of taxes or penalties. To enjoy this benefit, you can convert your Traditional IRA to Roth IRA and wait for the five year period to elapse.
The contributions on the Roth IRA investments are free from taxes if withdrawn at the age 59 ½ or later.
Roth IRA allows you to make contributions towards it even if you still participate in other qualified retirement plans for instance the 401(k).
You can diversify your portfolio in a variety of investment since Roth IRA has no limits to the number of investment you can make. Such investment includes individual stocks, mutual funds, ETFs, bonds and real estate.
Roth IRA allows your beneficiaries to acquire your Roth IRA assets not costs. Sole spouse beneficiary can even merge the existing accounts free of charge.
Cons of Roth IRA

Just as often, whenever there is a bright side, there must be dark side too. As much there are numerous advantages associated with Roth IRA, it is associated with a few drawbacks which include:

Roth IRA does NOT allow you to take tax deductions on its contributions.
IRS limits the amount you can contribute to Roth IRA in a given tax year.
In order for you to enjoy the benefit associated with earnings withdrawals, you should practically live longer once you retire.
The legislation is prone to changes and thus the benefits regarding tax free distributions can be stopped without any riposte.
As you have seen, Roth IRA is really a very attractive retirement plan. So do you plan to start a Roth IRA? Do you have a traditional IRA you wish to convert to Roth IRA? It is important that before you do so, you must first know the answer for the following question:  how does the Roth IRA work? You should also check Roth IRA calculator . We recommend you to start investing for your retirement as early as possible.

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