The Roth individual retirement account, or Roth IRA, is a variant of the traditional IRA that resulted from changes in tax laws that took effect in 1998. These two types of IRAs offer contrasting tax advantages -- a traditional IRA offers tax-free contributions, while a Roth IRA offers tax-free distributions.
As of 2012, you can contribute $5,000 per year to a Roth IRA until you turn 50. After that, you can contribute $6,000 per year. You must, however, have earned enough income during the tax year to equal the contribution you make that year. Although salary counts as earned income, capital gains and inherited income do not. A major exception to this rule is that if your spouse is working and you file taxes jointly, she can open a Roth IRA for you, and you can contribute to it even without earned income. You cannot deduct contributions to your Roth IRA from your taxable income.
The capital gains tax on amounts contributed to a Roth IRA is zero. Likewise, interest and dividends that arise from your contributions are not taxed. No matter how much your IRA assets grow, you will not owe tax on them as long as you don't make any unqualified withdrawals. For this reason, it is beneficial to invest your Roth IRA contributions profitably rather than allowing cash to accumulate in a savings account.
Distributions from a Roth IRA are considered "qualified" -- and therefore not taxable -- as long as they are made after the five-year period that begins the year the first contribution is made, and as long as you have reached age 59 1/2 by the time you take the distribution. Even if you have not reached the minimum age, distributions are still qualified if you are disabled, if the distribution is made to your beneficiary or to your estate after your death, or if distributions total no more than $10,000 and you use them to buy, build, or rebuild a first home for you, your spouse or certain other relatives.
If you make an unqualified withdrawal from your Roth IRA, you will be subject to a 10 percent penalty on any amounts that exceed your contributions -- capital gains, for example. This amount will be imposed in addition to the ordinary income tax you must pay on these amounts. You will not be taxed on any amounts that represent a return of your regular contributions, because you were already taxed on these amounts for the tax years in which you made them.
Video of the Day
- elderly,retirement image by Greg Pickens from Fotolia.com