Financial Tips: Roth IRA 101

In the numbers game of managing money, a Roth IRA can be a useful financial instrument to hedge against a possible increase in taxes during one's retirement years and a useful way to invest through a retirement instrument.

*Qualification: Roth IRA's are for employed people or the spouses of employed people. Money acquired through investments do not qualify for income in this case. This is a financial vehicle for working class through the upper middle class as the income requirements for opening an account can be no higher than 160K depending on filing status. For individuals and married persons filing separately, the earnings cap is set at $95-$110K with contribution phase out rules starting at 95$K, and for married persons filing jointly $150-160K with contribution phase out starting at $150K.

*Benefits: The benefits of Roth IRA's can include tax free capital gains and/or dividend income so long as the earnings are acquired are through the Roth IRA account. Also, there is no age limit to contribution nor is there a mandatory withdrawal required after a certain age is reached. This type of account can also be a useful hedge against complications in future government social security contributions.

*How to open an account: To open a Roth IRA one can either transfer a traditional IRA into a Roth or establish a new account with a banking institution provided that one is legally entitled to open such an account. Annual contributions can be no more than $4K for persons age 50 or lower and $5K for 51 or older with no age ceiling. Certain rules and restrictions may apply to persons with incomes near the cap range and self employed individuals.

*Tax benefits: The tax benefits of Roth IRA's are back end meaning the money deposited in a Roth is taxed i.e. not deductible on a tax return. However, it is not taxed upon withdrawal and may qualify for a retirement savings tax credit if you're over 20 as of 2007 and your adjusted gross income is less than $50K if married filing jointly or more than $25K filing singly.

Tips on Opening a Roth IRA:

As with many financial decisions the choices one makes are best applied to one's own circumstances. If one needs retirement contribution money for living expenses, a family emergency or some other unforeseen event the money contributed to a Roth is subject to taxation and a possible 10% penalty if withdrawn early. In other words, if you're going to need the money don't lock it up.

Secondly, the benefit of a Roth IRA is essentially as a tax hedge and savings regimen. If one has fiscal discipline and know how to gain a return higher than the tax savings incurred from both a predicted future tax adjustment and the tax savings on investments through the Roth IRA it may be better to choose other financial instruments.

Third, the tax free withdrawal incentive only becomes active at 59.5 years of age and beginning at least the fifth year after initial contribution.. The earlier and more one contributes to this account the better the tax savings will be IF taxes rise and/or your income tax bracket lowers after retirement.

In retrospect, one of the best benefits of a Roth IRA is the tax free income within the account. This can be a significant advantage in taxation because money that could earn 10% a year in a non-retirement account that is taxed as short term capital gains loses 10-35% outside of a non-tax sheltered investment vehicle. For example, if one's taxable income is the 15% tax bracket and acquires 5,000 in capital gains every year for 20 years, those capital gains will be taxed 15% a year or 15%*(5K*20 years)=$1500.00. Had that same money been a Roth IRA, not only would it be tax free saving the $1500.00, but the $1500.00 could be used to leverage more investments for a potentially greater gain overall.