Ultimate Guide to Roth IRAs

Planning for your retirement is an important part of maintaining your financial health. An individual retirement account or IRA represents one of several resources at your disposal. Depending on your individual circumstances, a Roth IRA may represent a smart addition or substitute for a traditional IRA.

One of the biggest distinctions between a Roth IRA and a traditional IRA is in how the IRS collects taxes from each type of account. Qualified taxpayers may make contributions to a traditional IRA that are initially tax-free. Then, the IRS collects taxes from it when the funds are distributed, presumably after you have retired. In contrast, contributions made to a Roth IRA are taxable as part of your reported income, but distributions are tax-free.

Related article: Can you have both a Roth IRA and Traditional IRA?

Another distinction between traditional and Roth IRAs concerns age limitations. The IRS does not permit contributions to traditional IRAs by taxpayers who are age 70 ½ or older. Also, taxpayers must begin taking distributions from traditional IRAs in the year following the year they turn 70 ½ and continue to take them as long as they live.

The IRS places no such restrictions on contributions to or distributions from Roth IRAs. You may continue to make contributions to a Roth IRA as long as you have income from wages or self-employment. You may also leave accumulated funds in a Roth IRA indefinitely if you are the original owner. (IRS.gov)

Traditional IRAs provide tax-deferred savings for taxpayers, Roth IRAs do not. But besides the absence of age restrictions, Roth IRAs provide significant benefits that traditional IRAs lack. For instance, once you have held a Roth IRA for five years or longer, qualified distributions are tax-free. As mentioned earlier, all distributions from a traditional IRA are taxable, regardless of circumstances.

Qualified distributions include those made to you after you reach age 59 ½ or at any age if you become disabled. Distributions to beneficiaries after your death are tax-free, as is a one-time distribution of $10,000 that is used toward the purchase of your first home. The ability to make contributions to a Roth IRA at any age and to take tax-free distributions is especially attractive if you intend to work past the age of 65.

The IRS allows eligible taxpayers to establish and maintain both types of IRAs. But the IRS places eligibility to contribute to Roth IRAs based on income and marital status. And if your retirement plan is through your job, there are extra restrictions. To determine what is best for your situation, consult with a qualified financial professional.

For 2014, single taxpayers and heads of household with modified adjusted gross income (MAGI) of $114,000 or less may contribute to a Roth IRA up to the annual limit. This limit is $5,500 for taxpayers 49 and younger, or $6,500 for taxpayers 50 and older. Those filing with MAGI between $114k and $129k may make reduced contributions indexed to their incomes. Those with MAGI over $129,000 may not contribute to a Roth IRA.

Married taxpayers filing jointly may each contribute to his or her own Roth IRA if their combined MAGI is $181,000 or less. Contribution limits are the same as for single taxpayers and heads of household. Married taxpayers filing jointly with MAGI of between $181,000 and $191,000 can make reduced contributions indexed to their incomes. The limits set for married couples filing separately but who lived together during any part of the previous tax year are especially stringent. Each member of a married couple filing separately can only contribute to a Roth IRA if his or her MAGI is $10,000 or less. (IRS.gov)

If you are eligible for both IRAs, it could make sense to divide your yearly contribution limits between both types. Doing so provides you with the greatest flexibility in contribution and distribution options. But it may be advisable to limit your contributions to a traditional IRA if you expect your taxable income to be reduced when you retire. If you believe your taxable income will be higher in your later years, opt for a Roth IRA.