Roth IRA Structure and Strategy

Setting money aside for retirement is one of the most important financial commitments that you can make in life. To secure a comfortable retirement, you may need to save up hundreds of thousands, if not, millions of dollars before leaving the work force. To help meet that end, you can put money in a Roth IRA. It is of course critical that you study the structure of this vehicle, before you coordinate the proper retirement plan strategy.

Roth IRA Tax Deferral

As a retirement account, the Roth IRA does allow for tax deferral. Tax deferral means that you will not be responsible for paying taxes on interest income, dividend payments, and capital gains as they occur within the Roth IRA. You will fund your Roth IRA with after-tax money, which allows for tax-free withdrawals upon retirement. A Roth IRA is therefore the mirror image of a Traditional IRA. The Traditional IRA provides for tax-deductible contributions, but your IRA withdrawals will be taxed as ordinary income.

Roth IRA Contribution Limits

As of 2011, you may generally contribute $5,000 for the year into Traditional and Roth IRA accounts, combined. If you are at least 50 years old, the combined contribution limit increases to $6,000. Be advised that legal Roth IRA contributions are phased out according to income level. As a single filer, you will not be able to make the full $5,000 Roth contribution, if you report modified adjusted gross income of at least $107,000. You will not be able to make any Roth IRA contributions, if you make at least $122,000 in modified adjusted gross income over the course of the tax year.

Roth IRA Additional Tax Penalty

You could be subject to a 10 percent additional tax penalty on Roth IRA withdrawals on gains made before age 59 ½. For example, you may contribute $5,000 into your Roth IRA to buy mutual funds at age 35. Two years later, your mutual funds appreciate in value to $7,000, before you sell off your position, withdraw cash, and close your Roth IRA account. At that point, you would owe the 10 percent additional penalty tax on $2,000 worth of gains.

To avoid the penalty tax, you should supplement your Roth IRA with cash, credit, insurance, and taxable brokerage accounts. Your goal is to be able to access cash in multiple economic scenarios -- so that you are not forced to tap your Roth in response to emergency situations. As a good rule of thumb, you should maintain six months worth of living expenses in cash reserves -- at all times.

Investment Strategy

A Roth IRA would be ideal if you are a young professional who expects to retire within a higher tax bracket. At retirement, you would then best take advantage of tax-free withdrawals. Because of the tax-free withdrawals, you should also place your most aggressive investments within the Roth IRA -- since it effectively bypasses capital gains taxes. International and small capitalization stock mutual funds are high risk / high reward Roth IRA investments that may be suitable for a younger saver. As you age and approach retirement, you can shift into bond and large capitalization stock funds for your Roth IRA.

Roth IRA Structure and Strategy, Sources:

IRS: Roth IRAs

IRS: 2011 IRA Contribution and Deduction Limits

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