Understanding The Benefits Of The Roth IRA

By: Garry Neale

A Roth IRA is a type of individual retirement account that differs from a traditional retirement account in many various ways. It is an account where you can invest in mutual funds or common shares and in order to have one you will need to follow some very strict IRS rules. Although the rules are strict, they are actual pretty straight forward and not that difficult to adhere to.

What is a Roth IRA?

The main reasons why people choose to open a Roth IRA is because of the way that the tax is set up on the account. Basically according to the rules, you make contributions only from your earned income which has already been tax deducted. Then any withdrawals which go up to the total contributions are basically federal income tax free. Any withdrawal above the contributions known as withdrawals of earnings, are free from federal income tax.

There is also a type of pensions account which mixes both traditional and Roth IRA features to form a Roth 401k. Now the this type 401k account is something which was set up in 1978. It allows people to save a certain amount of their pre-tax earnings into a savings account. Employers are in charge of putting the funds into the account and they can also choose to match your savings themselves; giving you two sources of money in the account instead of one.

All money which is in the Roth 401k account earns interest based on a tax deferred basis. Once you reach 59, you can start to get back qualified distributions from your account. The contributions which you receive are taxed at average income tax rates.

So the main difference between a Roth IRA and a Roth 401k is that with a the IRA contributions are paid in after tax has been deducted from the earnings. With the 401k, contributions are made before the tax has been deducted. When it comes to IRA limits, they do tend to be stricter than the 401k account. The IRA limits specify that you cannot contribute more than $4,000 a year if you are under 50 or $5,000 if you are over 50. However the IRS limits have been increased for 2008 slightly with $5,000 allowed to be saved if you are under 50 and $6,000 if you are over 50.

Another thing to keep in mind with Roth IRA rules is that you cannot contribute to one of these retirement accounts if you earn over $110,000 per year. You also cannot withdraw the money unless you have saved it in the account for at least 5 years.

So out of the Roth 401k and the ordinary Roth IRA, the 401k account is generally the most advantageous. The IRS rules on the account are not as strict and there are definitely more advantages to it. So if you are thinking of setting up a Roth account, then ensure that you follow all of the IRS rules and stick to the limits. Even though there are certain restrictions on a this type account, they are still much more advantageous than a traditional IRA account.

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