Roth IRA Rules and Avoiding Unnecessary Costs?

Answer 1

Roth individual retirement accounts (IRAs) have specific rules with regards to their use. If ignored, it can cost a saver a considerable expense.

First and foremost, only monies that have already been taxed can be deposited in an IRA. It's not possible to direct payroll earnings to a Roth before withdrawals and taxes have been applied to that income.

Next, Roth accounts have certain deposit requirements. While there is no minimum amount that must be deposited, the funds need to sit in the account at least five years from the time of the first deposit before a withdrawal can be made penalty free. Doing otherwise can trigger a 10 percent penalty that you will have to pay at income tax time. Total deposits per year are capped at $5,000 annually as of 2011.

There are exceptions to the withdrawal rule. If you are 59 _ years or older, withdrawals are penalty free. Additionally, if you withdraw the funds to pay for a first home purchase, secondary higher education costs, or critical medical bills, no penalties are applied either.

It is important to note that the penalties generally apply on the interest gained in the account after the first five years of savings. This is because the saver has already paid taxes on the funds, so it makes no sense in fairness to tax the funds again.

Finally, the major savings benefit of the Roth IRA involves expectation of earning in later years. Originally, people used a traditional IRA because they expected their tax level to be less in their later years, being retired. So withdrawals in the future earned in a high tax bracket would get taxed much lower when actually needed.

However, many people in the senior years today still bring in much more income than originally expected. As a result, the tax savings assumption didn't come true. The Roth IRA avoids this problem since once the funds are deposited today, they don't get taxed again, ever (unless Congress changes federal law). For those working later on in their senior years, this means they have a pot of savings that is essentially tax free when needed.

Roth IRAs can provide important retirement savings, but people need to pay attention to the account rules to avoid needlessly losing savings to penalties.