Roth IRA made easy
What are Roth IRAs and how do they work?
They are part of the family of Individual Retirement Accounts (IRAs). They have a special place in this family because they are completely tax free if you follow the basic rules. We’ll get to those rules in a moment.
Roth IRAs are like a special member of your retirement planning family, much like a trusty dog. They can faithfully care for your retirement “kitten” while keeping the tax wolf out of the door. But, like any dog, they can bite if you don’t know how to handle them.
So here are some basic rules to set up your Roth IRA to be a happy pet.
1. Make sure you’re eligible.
Qualified income: You are eligible if you also earned US taxable income from any of these sources: salaries, wages, tips, professional fees, bonuses, commissions, self-employment income, tax-free combat pay, military differential pay, or taxable alimony. (Unfortunately, investment and rental income do not qualify.)
Also, your income must be below certain levels to qualify. For a 2011 contribution (made by 16 April 2012) your income must not exceed the following:
Unmarried: Modified adjusted gross income (MAGI) must be below $107,000, with a phase-out range up to $122,000 for partial contributions.
Married filing jointly (MFJ): total income must be below $169,000 MAGI, with phase-out range up to $179,000.
Head of household or married filing Separately who did no you live with your spouse during the tax year: $107,000 MAGI with the same phase-out range as Single.
Married, filing separately WHO I did you live with your spouse during the tax year: You can’t contribute if you have earnings over $10,000. Reduced amount below that.
Your modified adjusted gross income is the adjusted gross income (AGI) on your tax return, adjusted for things like student loan interest deductions, rollover conversions, and foreign income. Many people don’t have many of these and can just use the AGI from their tax return.
2. How to Keep Your Roth IRA Tax Free
Keep it for at least five years and until age 59 or later. Remember, IRAs are for retirement, so it’s best to keep them going until your later years.
If you really need to use the money before you’ve qualified for tax-free status, you can take it out under various hardship clauses. Some of these exceptions include using an IRA for a first home purchase (up to $10,000 of IRA money you’ve owned for 5+ years), disability, paying qualified educational expenses (tuition, books, school fees), or paying for health insurance. if you are unemployed.
You can also withdraw from an IRA under the substantially equivalent periodic payment (SEPP) rules. Get help if you want to do this as it can be difficult. There’s a potential bite from the IRS if you get it wrong.
You can always take your own installments out anytime without penalties or taxes, just not your earnings. For a complete list of ways to withdraw money from a Roth IRA without penalty, check IRS Publication 590 or the book Roth IRA made easy.
What’s the “bite” if you take the money early? That’s a 10% penalty on your Roth IRA earnings, plus taxes paid.
3. Know when, what and how much you can contribute to your Roth IRA.
If you meet the requirements, you can include smaller of: your annual earned and taxable compensation OR the IRA limit for that year. You can never contribute more to an IRA than you earned (or will earn) for that calendar year.
Annual IRA contribution limits are the same for both traditional and Roth IRAs. For 2011, it’s $5,000 for people under 50 and $6,000 for those 50 or older. Each year, the government announces the IRA contribution limits for that year, and they tend to increase gradually over time.
There is a 15-month contribution window for each year. The window begins to open on January 1 of the year and closes on April 15 (or the tax return filing date) of the following year. For example, for the 2011 calendar year, you can donate from January 1, 2011 to April 16, 2012.
What types of investments can you make? Use almost any type, such as mutual funds, stocks, bonds, certificates of deposit (CDs), exchange-traded funds (ETFs), and more.
A Roth IRA can be a great way to save for your future. It can provide you with truly tax-free earnings – potentially thousands of dollars in savings over many years.
In addition to this benefit, Roth IRAs do not have any required minimum distributions (RMDs). Most employer retirement plans and other IRAs require you to start withdrawing your money (and taxing it) when you turn 70 1/2. Roth IRAs are happy retirement darlings that will happily wait until you’re ready to use them.
#Roth #IRA #easy
