Myth 1. Use the university medical plan. You need to understand your current medical insurance plan. Many plans have increased costs for out-of-network doctors, however, it could be even more expensive to use the medical insurance your school offers. Do a comparison of the plans and costs; just make sure you don’t go without any insurance.

Myth 2. You must wait until after college to start a retirement plan. College is a great time to start a Roth IRA. Put away some of the money you earn from your summer or part-time job in a Roth IRA during college. This was one of the key reasons I was able to leave the workforce at 29.

Myth 3. You must pay your tuition with a check. Find out if you can pay your tuition on a credit card. If so you can use cash rewards credit cards to get cash back on your tuition. My aunt mentioned this weekend that was her plan. Great idea!

Myth 4. Buy everything for your dorm room. Instead, give your new roommate a call. By coordinating bigger items, you’ll save some money and avoid showing up with two toasters and no t.v.

Myth 5. Always use the meal plan. I can’t tell you how much money I wasted on the meal plan since you could only add money in $250 increments. Plan ahead and you won’t have to spend $200 on food in one week! In addition, be sure to check out other options for cheaper (and healthier) food choices.

Myth 6. Keep using your hometown bank. You may want to explore local banks in your college town. Our university had a free credit union with branches all over campus. They had free ATMs, checking and savings accounts. It might be more convenient than your old bank.

Myth 7. Buy everything you could possibly need. You can save a bundle by waiting to finish your shopping. Before leaving for school, I made sure to buy everything on those college checklists. It wasn’t until I was there that I realized I could still go to a store and buy some stuff; you might find you don’t even need it all to begin with.

Myth 8. Assume your belongings are insured. Inform your insurance agent that you are moving out. Determine if your belongings will be insured under your homeowners policy, or check out a renters policy. You’ll also want to let them know if you are taking your car, as it will be garaged at a new location. Don’t end up uninsured in the event of a fire or other catastrophe.

Myth 9. Student loans are the only option to finance your education. Being frugal in college doesn’t have to ruin your fun. Check out how to be a frugal college student for ideas.

Myth 10. Buy your textbooks immediately. Wait until after your first class to see if you need a certain version of the recommended text. Other textbook tips for college students include shopping for books online and reselling them once you are finished.

IRAs were created to encourage people to save for their retirement, by offering them a significant tax break.
They are intended for ordinary working people - not, for example, the wealthy (income limits prevent them from participating),
or trust fund kids too lazy to get a job (contributions have to be made from salary, not from investments or other income).

The rules for eligibility and contribution limits change every year.
You can (and should) get the official rules from IRS Publication 590;
but to help make things clear, here is a quick and user-friendly (but not official!) summary:

IRA Contribution Limits

To summarize how all of the rules work:

1. If your status is Married Filing Separately you are effectively locked out due to an extremely restrictive limit.
   (The rationale: the government doesn’t want to give you a tax break in case your spouse is high-income.
   The exception: if you and your spouse lived apart for the whole year, you get the same limits [and same bummer lifestyle] as a Single filer.)
2. If your status is anything else, then your contribution limit is (using 2008 numbers):
   

   $5000 if your income is low enough (and $6000 if you’re 50 or older) zero (that is, you can’t contribute at all) if your income is too high a sliding scale somewhere in between, if your income is somewhere in between “low enough” and “too high”

3. In case you have multiple IRAs, the limit is the total you are allowed to contribute to all of them
4. And in all cases, your total contributions can’t be greater than your reported salary income.

If you don’t qualify…

If your income is too high to make a Roth IRA contribution, you may still be eligible for a traditional deductible IRA
if neither you nor your spouse is covered by a retirement plan at work.
See IRS Publication 590.
(Look under “Traditional IRAs”.)

Penalties

A Roth IRA is intended to be a retirement account, so penalties apply if you misuse it by withdrawing funds too early.
As a rule, you should plan not to make any withdrawals until at least age 59½ or five years after you make your first contribution, whichever comes later.
This rule does have exceptions: see
IRS Publication 590
for details. (Search for “Qualified Distributions”.)

A Roth IRA is an Individual Retirement Account that provides tax-free growth. As a result, it’s the simplest - and potentially the most effective - sheltered account imaginable.

The Roth Tax Advantage

Try our financial calculators!

Please try our wide variety of financial calculators. Interactive calculations, dynamic graphs and fully customizable reports are just a few of the features that make our calculators stand out!

Roth IRA Calculator Use this calculator to compare the Roth IRA to an ordinary taxable investment

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Roth vs. Traditional IRA Use this calculator to determine which IRA may be right for you.

This article was updated in 2008.

One of the smartest money moves a young person can make is to invest in a Roth IRA. Follow the rules and any money you put into one of these retirement-savings accounts grows absolutely tax free — you won’t owe Uncle Sam a dime as you let your savings accumulate, or when you cash it out in retirement. Plus, an IRA is more flexible than a 401(k) and other retirement plans because you can invest it in almost whatever you want, from stocks and mutual funds to bonds and real estate.

If you haven’t yet opened this gift from Uncle Sam, do it now. The government sets a limit on how much you can contribute to a Roth. That limit is $5,000 in 2008.

Q. I intend to retire at age 50. When I do, I’ll need income. Can I take money from my Roth IRA without paying any taxes or penalties?

A. Potentially, yes. Under the IRS ordering rules, you are allowed to remove your original contributions at any time without tax or penalty. In addition, after you’ve waited at least five tax years, you’re able to withdraw your original converted amounts without taxes or penalties. It’s only when you get to the earnings generated by the original contributions and conversions that you will have a tax and/or penalty problem.

Even if you do determine that you’ll have to break into the earnings prior to age 59-1/2, you may still avoid the penalty (but not necessarily the tax). If you remove the funds from your Roth IRA account using a distribution method that is part of a scheduled series of substantially equal periodic payments made over your life expectancy (and the life expectancy of your beneficiary), you may still be penalty-free.

You must receive taxable compensation during the year To contribute to an IRA (Roth or traditional), you must receive taxable compensation during the year. For purposes of IRA contributions, taxable compensation includes wages, salaries, commissions, self-employment income, and taxable alimony or separate maintenance. Other taxable income, such as interest earnings, dividends, rental income, pension and annuity income, and deferred compensation, does not qualify as taxable compensation for this purpose. Your contribution for a given year cannot exceed your taxable compensation for that year.

Tip: The 2006 Heroes Earned Retirement Opportunities (HERO) Act allows members of the Armed Forces to include nontaxable combat pay as part of their taxable compensation when determining how much they can contribute to an IRA (their own or a spousal IRA) in tax years beginning after December 31, 2003. Prior to the Act, a serviceman or woman with only nontaxable combat pay was unable to make an IRA contribution. Service members have until May 28, 2009, to make retroactive IRA contributions for 2004 and 2005, and will have at least one year following the date of their contribution to claim any credit or refund that they may be entitled to for those years. For service members with only nontaxable combat pay, Roth IRA contributions will generally make more sense than nondeductible contributions to a traditional IRA.

Your ability to make annual contributions depends on your income and filing status If you file your federal income tax return as single or head of household and your MAGI for 2008 is $101,000 ($99,000 for 2007) or less, you can make a full contribution to your Roth IRA. Similarly, if you file your return as married filing jointly or qualifying widow(er) and your MAGI for 2008 is $159,000 ($156,000 for 2007) or less, you can make a full contribution. Otherwise, your allowable Roth IRA contribution is reduced or eliminated as follows:

*These income ranges are indexed for inflation each year.

If you are married filing a joint return, you may be able to contribute to a Roth IRA for your spouse even if he or she has little or no taxable compensation. If you are married filing separate returns and you lived apart from your spouse at all times during the taxable year, you are treated as a single taxpayer for purposes of the Roth IRA rules.

Tip: To calculate the exact amount of your allowable Roth IRA contribution, a step-by-step worksheet is available. See IRS Publication 590, Individual Retirement Arrangements (IRAs). Tip: These income limits don’t apply to rollover contributions to your Roth IRA.

You must not have already contributed the annual maximum to your traditional IRA Total contributions to all of your IRAs (traditional and Roth) cannot exceed $5,000 for 2008 ($6,000 if you’re age 50 or older). If you contribute the maximum allowed to your traditional IRA for any year, you cannot contribute to your Roth IRA at all for that year. If you make a partial contribution to your traditional IRA, your allowable Roth IRA contribution for that year is equal to the difference between the annual IRA contribution limit and the amount contributed to your traditional IRA (or vice versa).

Example(s): You have a traditional IRA and a Roth IRA. You contribute $2,900 to your traditional IRA for the year. You can contribute no more than $2,100 to your Roth IRA for that year ($3,100 if age 50 or older). Caution: The Pension Protection Act of 2006 provides that an active reservist or guardsman who receives a qualified reservist distribution can repay all or part of that distribution to an IRA at any time during the two year period beginning on the day after active duty ends (or, if later, the two year period beginning August 17, 2006). The regular IRA contribution limits don’t apply to these repayments. A qualified reservist distribution is a payment from an IRA, or a payment of elective deferrals and earnings from a 401(k) plan or 403(b) plan, to an active reservist or guardsman who is called to duty after September 11, 2001, and before December 31, 2007, for a period in excess of 179 days (or for an indefinite period). Caution: The Pension Protection Act of 2006 allows certain individuals who participated in the Enron Corporation 401(k) plan to make special IRA catch-up contributions of up to $3,000 per year for tax years 2007 through 2009. Taxpayers who make these special contributions aren’t allowed to make age 50 catch-up contributions. Tip: The annual contribution limits ($5,000 in 2008, $4,000 in 2007) don’t apply to rollover contributions.

A Roth individual retirement account (IRA) is a personal savings plan that offers certain tax benefits to encourage retirement savings. Contributions to a Roth IRA are never tax deductible on your federal income tax return, which means that you can contribute only after-tax dollars. But amounts contributed to the Roth IRA grow tax deferred and, if certain conditions are met, distributions (including both contributions and investment earnings) will be completely tax free at the federal level.

A Roth IRA, like a traditional IRA, is not itself an investment, but a tax-advantaged vehicle in which you can hold some of your investments. You need to decide how to invest your Roth IRA dollars based on your own tolerance for risk and investment philosophy. How fast your Roth IRA dollars grow is largely a function of the investments you choose to fund the IRA.

For 2008, you can contribute up to the lesser of $5,000 or 100 percent of your taxable compensation to a Roth IRA. You may also be able to contribute up to $5,000 to a Roth IRA in your spouse’s name even if he or she receives little or no taxable compensation (see Spousal IRAs). However, not everyone qualifies to use the Roth IRA. Even if you do, you may not qualify to contribute the annual maximum. The amount you can contribute to a Roth IRA (if any) depends on your modified adjusted gross income (MAGI) for the year and your federal income tax filing status.

Tip: The Economic Growth and Tax Relief Reconciliation Act of 2001 (2001 Tax Act) increased the annual IRA contribution limit (combined, for traditional and Roth IRAs) from $2,000 to $3,000 per person each year for 2003 and 2004, $4,000 for 2005 through 2007, and up to $5,000 each year for 2008 and beyond. These contribution limits are indexed for inflation beginning in 2009. The law also allows taxpayers age 50 and older to make additional “catch-up” contributions. These individuals can put up to $3,500 each year in their IRAs for 2003 and 2004, $4,500 for 2005, $5,000 in 2006 and 2007, and $6,000 each year for 2008 and beyond.

Tip: Consider contributing to a Roth IRA rather than a traditional deductible IRA if you expect that you may be in the same or a higher federal income tax bracket when you retire. If you can’t make deductible contributions to a traditional IRA and are trying to decide between making nondeductible contributions to a traditional IRA or contributing to a Roth IRA, you should probably choose the Roth IRA. If you are eligible to contribute to a Roth IRA, there is generally no advantage to making nondeductible contributions to a traditional IRA.

Tip: If you participate in a 401(k) or 403(b) plan at work, you may be able to make Roth contributions to the plan. Qualified distributions of these contributions and related earnings may be income tax free (and penalty free) at the federal level. The ability to make Roth contributions to your employer’s plan may be a factor in your decision of whether to contribute to a Roth IRA, or convert funds from a traditional IRA to a Roth IRA. Be sure to discuss your situation with a qualified professional before making any decisions. For more information, see Roth 401(k).

Caution: Special rules apply to qualified individuals impacted by Hurricanes Katrina, Rita, and Wilma; certain former Enron employees; and certain distributions to active duty reservists and national guardsmen after September 11, 2001.

You can contribute only after-tax dollars Contributions to a Roth IRA are never tax deductible on your federal income tax return. In other words, you can contribute only after-tax dollars to a Roth IRA. This is in contrast to a traditional IRA, which may allow you to deduct your contributions under certain conditions.

Contributions are limited to the annual maximum (or possibly even less) You cannot contribute a total of more than $5,000 per year to all of your IRAs (Roth and traditional) for 2008 ($6,000 if you’re age 50 or older by the end of the calendar year).

Example(s): You have two traditional IRAs and a Roth IRA. You can contribute no more than $5,000 overall in 2008. You can contribute the entire $5,000 to any of the three IRAs, or you can divide the $5,000 contribution among them in any manner you choose.

Tip: You may also be able to contribute up to $5,000 to an IRA in your spouse’s name in 2008 even if he or she has little or no taxable compensation ($6,000 if your spouse is age 50 or older). See Spousal IRAs. Caution: The Pension Protection Act of 2006 provides that an active reservist or guardsman who receives a qualified reservist distribution can repay all or part of that distribution to an IRA at any time during the two year period beginning on the day after active duty ends (or, if later, the two year period beginning August 17, 2006). The regular IRA contribution limits don’t apply to these repayments.

Caution: The Pension Protection Act of 2006 allows certain individuals who participated in the Enron Corporation 401(k) plan to make special IRA catch-up contributions of up to $3,000 per year for tax years 2007 through 2009. The regular IRA contribution limits don’t apply to these repayments. Taxpayers who make these special contributions aren’t allowed to make age 50 catch-up contributions.

Tip: The annual contribution limits don’t apply to rollover contributions.

Your ability to contribute in 2008 depends on your income and tax filing status

*These income ranges are indexed for inflation each year.

Tip: If you are married but did not live with your spouse at any time during the year and you file a separate return, you are considered single for Roth IRA contribution eligibility purposes.

Withdrawals are taxable under certain conditions A withdrawal from a Roth IRA (including both contributions and investment earnings) is completely tax free only if it is a qualified distribution (see Strengths, above).

If your withdrawal is a nonqualified distribution, the portion of your distribution that represents investment earnings will be subject to federal income tax, and may also be subject to a 10 percent premature distribution tax if you are under age 59½ (unless one of the exceptions applies). Only the portion of a nonqualified distribution that represents your contributions will not be taxed or penalized, since those dollars were taxed once already.

Caution: Long-term capital gains are generally subject to tax at rates that are lower than ordinary income tax rates. Additionally, under the Jobs and Growth Tax Relief Reconciliation Act of 2003, qualifying dividends paid to individual shareholders from domestic corporations (and qualified foreign corporations) are taxable at the lower long-term capital gains tax rates as well. Taxable distributions from IRAs that represent such long-term capital gains and dividends, however, will not enjoy this tax benefit–they are taxable at ordinary income tax rates.

Special penalty provisions may apply to withdrawals of Roth IRA funds that were converted from a traditional IRA If you roll over or convert funds from a traditional IRA to a Roth IRA, special rules apply. If you are under age 59½, any nonqualified withdrawal that you make from the Roth IRA within five years of the rollover or conversion may be subject to the 10 percent premature distribution tax (to the extent that the withdrawal consists of converted funds that were taxed at the time of conversion). The reason for this special rule is to ensure that taxpayers don’t convert funds from a traditional IRA solely to avoid the early distribution penalty. See Converting or Rolling Over Traditional IRAs to Roth IRAs for more information. See Premature Distribution Rule for exceptions to the 10 percent penalty tax.

Tip: The five-year holding period begins on January 1 of the tax year in which you convert the funds from the traditional IRA to the Roth IRA. When applying this special rule, a separate five-year holding period applies each time you convert funds from a traditional IRA to a Roth IRA.

Caution: This 5-year period may not be the same as the 5-year period used to determine whether your withdrawal is a qualified distribution.

Example(s): In 2005 you open your first Roth IRA account by converting a $10,000 traditional IRA to a Roth IRA. You include $10,000 in your taxable income for 2005. You make no further contributions. In 2008, at age 55, your Roth IRA is worth $12,000, and you withdraw $10,000. The distribution is not a qualified distribution because 5 years have not elapsed from the date you first established a Roth IRA. And because you are making a nonqualified withdrawal within 5 years of your conversion, the entire $10,000 is subject to a 10% premature distribution tax unless you qualify for an exception. This “recaptures” the early distribution tax you would have paid at the time of the conversion. You open a regular Roth IRA account in 2001 with a contribution of $100, and make no further contributions to the account. In 2005, at age 60, you convert a $100,000 traditional IRA to a Roth IRA. In 2008 you withdraw $50,000 from this Roth IRA. Because you are over age 59½ in 2008, and because more than 5 years have elapsed from January 1, 2001 (the year you first established any Roth IRA), your withdrawal is a qualified distribution and is totally free of federal income taxes. Even though your withdrawal was within 5 years of the conversion, no penalty tax applies.

States differ in their treatment of Roth IRAs Although most states follow the federal income tax treatment of Roth IRAs, some may not. You should check with your tax advisor regarding the tax treatment of Roth IRAs in your particular state. In addition, some states may provide Roth IRA funds with less creditor protection than they provide traditional IRA funds.

Tip: Federal law provides protection for up to $1,095,000 (as of 4/1/07) of your aggregate Roth and traditional IRA assets if you declare bankruptcy. (Amounts rolled over to your Roth IRA from an employer qualified plan or 403(b) plan, plus any earnings on the rollover, aren’t subject to this dollar cap and are fully protected.) The laws of your particular state may provide additional bankruptcy protection, and may provide protection from the claims of your creditors in cases outside of bankruptcy.

The law may change in the future Most of the advantages offered by the Roth IRA depend on the federal government’s promise that qualifying distributions from Roth IRAs will always be tax free. It is unlikely, but if the law changes, all bets are off. Remember that Social Security benefits were once not subject to federal income tax, but federal law was later changed to tax a percentage of such benefits in certain situations.

Income Tax Contributions to a Roth IRA are made with after-tax dollars Unlike deductible contributions to a traditional IRA, you do not have the option of deducting Roth IRA contributions and reducing your taxable income on your federal income tax return. You can contribute only after-tax dollars to a Roth IRA.

Qualified distributions are tax free A withdrawal from a Roth IRA (including both contributions and investment earnings) is completely tax free (and penalty free) at the federal level if made at least five years after you first establish any Roth IRA, and if one of the following also applies:

You have reached age 59½ by the time of the withdrawal The withdrawal is made due to qualifying disability The withdrawal is made to pay for first-time homebuyer expenses ($10,000 lifetime limit) The withdrawal is made by your beneficiary or estate after your death Tip: The five-year holding period begins on January 1 of the tax year in which you make your first contribution (regular or rollover) to any Roth IRA. Each taxpayer has only one five-year holding period for this purpose.

Even if a withdrawal does not qualify for tax-free treatment, only the portion representing earnings is taxable If you make a withdrawal from a Roth IRA that does not meet the above conditions, the portion of the withdrawal that represents investment earnings will be subject to federal income tax at ordinary income tax rates (even if the funds represent long-term capital gains or qualifying dividends), and may also be subject to a 10 percent premature distribution tax if you are under age 59½. However, the portion of the withdrawal that represents Roth IRA contributions will not be subject to federal income tax or penalty as those dollars were already taxed. Roth IRA withdrawals are treated as being made from contributions first and investment earnings last. All of your Roth IRAs are aggregated when determining the taxable portion of your nonqualified distribution.

Technical Note: Technically, a distribution from a Roth IRA that is not a qualified distribution, and is not rolled over to another Roth IRA, is included in your gross income to the extent that the distribution, when added to the amount of any prior distributions (qualified or nonqualified) from any of your Roth IRAs, and reduced by the amount of those prior distributions that were previously included in your gross income, exceed your contributions to all your Roth IRAs. For this purpose any amount distributed to you as a corrective distribution is treated as if it was never contributed. Caution: If you convert funds from a traditional IRA to a Roth IRA, special rules may apply if you subsequently withdraw funds from the Roth IRA. See Converting or Rolling Over Traditional IRAs to Roth IRAs.

Gift and Estate Tax When you die, the assets in your Roth IRA are considered when determining if estate tax is due Unless you name your spouse as beneficiary (unlimited marital deduction) or a charity as beneficiary (charitable deduction), the full value of your Roth IRA at the time of your death is included in your taxable estate to determine if federal estate tax is due. In addition, your state may impose a state death tax.