Roth IRA: What is it?
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.