A Roth IRA (Individual Retirement Arrangement) is a special type of retirement plan under US law that is generally not taxed, provided certain conditions are met. The Roth IRA was established by the Taxpayer Relief Act of 1997 (Public Law 105-34) and named for its chief legislative sponsor, Senator William Roth of Delaware.
The Roth IRA’s principal difference from most other tax advantaged retirement plans is that, rather than granting a tax break for money placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement.
A Roth IRA is also a personal savings plan but operates somewhat in reverse compared to a traditional IRA. For instance, contributions to a Roth IRA are not tax deductible while contributions to a traditional IRA may be deductible. However, while distributions (including earnings) from a traditional IRA may be included in income, the distributions (including earnings) from a Roth IRA are not included in income. For both IRA types – traditional and Roth – earnings that remain in the account are not taxed. A Roth IRA can be established at the same types of financial institutions as a traditional IRA
In contrast to a traditional IRA, contributions to a Roth IRA are not tax-deductible. Withdrawals are generally tax-free, but not always and not without certain stipulations (i.e., tax free for principal withdrawals and the owner’s age must be at least 59½ for tax free withdrawals on the growth portion above principal). An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements. In other words, withdrawals or distributions are tax-free so long as the Roth IRA holder is over the age of 59/1/2 and the individual has had made a Roth IRA contribution to any Roth IRA at least 5 years earlier. However, if the individual wants to take a distribution prior to turning 59/1/2 and having made a Roth IRA contribution for at least five years, the individual has to pay tax and penalty on any appreciation. Thus, if the individual is 45 and made a $5,000 Roth IRA contribution and now the Roth IRA is worth $8,000, and the individual wanted to take a $8,000 withdrawal/distribution, the individual would have to pay tax and penalty of the $3,000 of appreciation.
- Contributions are not tax deductible. Maximum after- tax non- deductible contribution for 2016 is $5,500 ($6,500 for those over the age of 50). Contributions must be made prior to April15.
- No Mandatory Distribution Age
- All earnings and principal are 100% tax free if rules and regulations are followed
- Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
- Available only to single-filers making up to $132,000 or married couples making a combined maximum of $194,000 annually.
Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).