An IRA (which stands for Individual Retirement Account) is a savings or investment account with huge tax breaks, making it a great way to grow your retirement nest egg. The IRA itself is not the investment vehicle – but it’s just the basket in which you keep your stocks, bonds, mutual funds, savings, and other assets. There are several different types of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. The focus of this article is on the Roth IRA and it’s unique advantages.
A Roth IRA allows your money to grow tax-free. You fund the account with money that has already been taxed so money in the plan grows tax free from the grips of Uncle Sam. All income earned from interest, dividends and capital gains can compound each year without taxes nipping away at it. Roth IRAs are funded with after-tax money and you pay no taxes on the back end when you begin taking out savings for retirement. So in return for no up-front tax break, your money grows and grows tax free, and when you withdraw at retirement, you pay no taxes. That’s right – every penny goes straight in your pocket – a very good deal indeed.
The government limits the amount of money you can put into an IRA each year. If you’re younger than 50, your 2016 contributions are limited to $5,500 or the total of your taxable compensation, whichever is smaller. If you are age 50 or over, you are allowed to contribute up to an additional $1,000 for a total yearly contribution of $6,500. If your modified adjusted gross income less than $117,000 (for singles), or $184,000 (for married couples filing jointly) you can make the full contribution in 2016. If you earn slightly above those amounts, you may be able to make smaller contributions.
Generally, you may withdraw your contributions to a Roth penalty-free at any time for any reason, as long as the withdrawal is from money (your capital) you put into the Roth and not withdrawal of the “earnings” made on your investments. In that case, you will get hit with that same 10% penalty. You can leave your money in a Roth IRA for as long as you want, letting it grow and grow as you get older and older. With a traditional IRA, by contrast, you must start taking out your money by the time you reach age 70½.
A Roth IRA has many benefits. A key advantage is to open your Roth and start contributing at an early age – as soon as you can after starting to earn income. Imagine the amount of tax-free savings you can accumulate by starting to sock away money in your 20s or 30s. Even if in your 40s, 50s or older, it is not too late to open and fund a Roth IRA.
