Galia Gichon, speaker at this past CFC in Denver, and owner of Down to Earth Finance, is the voice of reason for investment newbies and veterans alike. She just put out an extremely helpful newsletter about the benefits of a ROTH IRA. If you don’t have one yet, this is a must read!
ROTH IRAs, you either love them or know nothing about them. I am a fan of them for most people. The ROTH IRA is an individual retirement account with special tax benefits. Your contributions are made with after-tax dollars and it grows tax-deferred. When you start withdrawing the money at age 59 ½, it is TAX-FREE.
In 2010, you can contribute up to $5,000 and an additional $1,000 if you are over 50. You can only contribute to or open a ROTH IRA if you make less than $120,000 as a single person or $177,000 as a couple. If you make more than the income limit the next year, you can't add any more money to your existing ROTH IRA. However, nothing will happen to your existing ROTH IRA; you have to open a Traditional IRA. If you have a year in the future where your income dips below the income limit you can add to your ROTH IRA again.
A great benefit of the ROTH IRA is that if the principal has been in the account for at least five years, there is no penalty to take the money out.
There is also no penalty if it is used for a first-time home purchase, qualified education expense or certain medical hardships. The only reason I do not like the ROTH IRA is that many self-employed people use the ROTH as their primary retirement plan. While the tax benefits are amazing, it also means that they are ONLY saving $5,000 a year. That isn’t enough. So, if you are self-employed, push yourself to open a SEP IRA, which lets you put a lot more money away. If you work for a company that offers a 401k, focus on maximizing the contributions to your 401k first, then open the ROTH IRA.
One last point about the ROTH IRA is you can convert other IRAs to a ROTH IRA in 2010. If you decide to do this, you will owe taxes right now. Make sure you have the money in savings to pay the taxes. The benefit is that old 401ks, SEP IRAs or Traditional IRAs are now converted to a ROTH IRA and you will not have to pay taxes when you take the money out after age 59 ½. You might be hit with a large tax bill now, so be sure to check with your accountant.
If this information is useful to you, check out Galia’s My Money Matters Toolkit, which provides everything you need to get your personal finances on track.