What is Roth IRA and How Does it Work

Medha Godbole Jan 6, 2019
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Speculating about what is Roth IRA and how does it work? Maybe, it will be the end of your queries about Roth IRA, after reading here.
Financial insecurity is what takes away the peace of mind from an individual more than anything else. Since the past few years, the awareness towards senior citizens has increased, as a result many retirement and senior citizen benefits are being given. One amongst such schemes is the Roth IRA.

What is a Roth IRA?

Roth IRA refers to an Individual Retirement Account (IRA), which is allowed as per the tax law of the USA. It is named so after its chief legislative sponsor, late Senator William Roth of Delaware. This provision has been established by the Taxpayer Relief Act of 1997 (Public Law 105-34).
The best part about it is that, contributions to it are not eligible for a tax deduction the year it is invested in. It grows tax free and distributions are not taxed after retirement. It is basically a retirement account.

How Does it Work?

Point 1

A Roth IRA is different from other retirement accounts in quite a few aspects. To begin with, in a Roth IRA, an investor first pays income tax on income earned from work or alimony. The tax payer then makes contributions to the account using post taxation money. This is what makes it different from a regular IRA.

Point 2

How much ever money you invest in Roth IRA, it will increase, and it will be free of tax. Besides, there is no federal taxation when the person who has the account withdraws the money.

Point 3

Another good thing about the working of Roth IRA is that when you withdraw the earnings, they are tax free, if you are above 59 ½ years of age. This provision lasts for as long as minimum 5 years since the establishment of a Roth account.

Point 4

A Roth IRA gives freedom to the investor to put monetary contributions in almost any vehicle investment or bonds, stocks, mutual funds and even real estate. The investor has all the chance to make investment choices which match his or her retirement costs.

Conversion from Traditional IRA to Roth IRA

Quite a few investors after knowing what is Roth IRA and how it works, want to convert from a regular IRA to a Roth IRA, obviously to take an advantage of tax benefits. So, if you are planning to get a new account all together, you would be required to fulfill the requirements for that.
In case you want to convert an existing IRA into a Roth IRA, you have to meet the income requirements for that tax year. Doing this means cashing out of your traditional IRA, and putting that money in Roth IRA. Although paying taxes on your regular IRA distribution is mandatory, even when you deposit the funds in the both the IRA's.

Advantages

  • It is possible for a person to invest in a Roth IRA account as well as an employer based retirement savings plan.
  • When it comes to Roth IRA, even the minimum distribution rules do not apply. It means that anyone more than 59 ½ years of age with other sources of income, can let the account be, and can get the benefit of earnings, which will grow tax free.
  • Another very important benefit of it is the ability to take out early distributions sans paying an early distribution penalty.
  • At any time, till $10,000 in earnings withdrawals for an individual, and $20,000 for a couple can be withdrawn from a Roth IRA. It will be tax and penalty-free, as long as the account has been active for at least five years.
In case you are keen on knowing more about Roth IRA and its working and want to open that account, most brokerage firms, credit unions, banks, mutual fund companies, investment firms and insurance companies can help you out with this. Good luck!