My last post on saving money had some interesting comments (Thanks to everyone who reads, Likes, Tweets or comments!) that got me thinking about my next topic. I decided to take a specific topic (retirement accounts) and explore it a little more in-depth. I want to talk specifically about Roth IRA’s and how they can benefit savers and investors.
I want to emphasize that Roth IRA’s are absolutely not for everyone and not even possible for many people. Before you decide to go down the Roth IRA path, first make sure you are eligible and take some time to read through the links at the end of the article. Also, this is a very complex topic
What is a Roth IRA?
As always, for finance related questions, I recommend going to Investopedia. They are a great resource for user-friendly information on complex financial topics. There are two forms of Roth retirement accounts. The Traditional IRA and the Roth IRA.
In a Traditional IRA, your contributions are tax-deductible, but your withdrawals are subject to federal income tax. A Roth IRA is a retirement account which you contribute money after taxes, it is coming out of your disposable income. A good way to think of the difference is that in a Roth IRA you are contributing after-tax money now for the right to avoid taxes on future distributions.
The Roth IRA format is simpler for retirement planning because you don’t need to worry about the tax liability upon withdrawal. Distributions are free of tax and penalty assuming you have held the account long enough (5 years) and are either old enough (59.5) or have a valid reason (disability). You are trading the taxes on today’s money for no taxes on the appreciation.
According to current tax law, Traditional IRA’s can be converted into Roth IRA’s. This may change at any time, so please do some personal research before making decisions and talk to a professional.