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Money Management

 
 

Roth IRAs

 

One of the best ways to save for long-term goals (retirement) is a Roth IRA. Many people have heard of an IRA, but do not have a clear understanding of what they are, how they work, who can participate, etc.

  • A Roth IRA is an Individual (not joint) Retirement Account that lets you benefit from tax-free interest growth providing you meet certain conditions. Something that many people do not understand is that a Roth IRA is not a "product" – it is more like a "basket" that investment products are put into. Many people like mutual funds (no load Mutual Funds of course) because of the instant diversification they provide, but you can also invest in individual stocks, bonds, CDs, or whatever other investment vehicles are available through the financial institution you’re opening a Roth IRA with.

  • This IRA is named for Senator William Roth (Delaware) who spearheaded the effort to create it.

  • You can contribute to a Roth IRA if you have earned income. In 2004 you can contribute up to $3,000 (or the amount of your earned income, whichever is less). In 2005, the amount increases to $4,000. With the Roth IRA, you have until April 15th of each year to contribute – in other words, you still have time to open a Roth IRA and contribute for 2004 as long as it’s done prior to April 15, 2005. If you’re over 50, you can contribute an additional $500 as a "catch up" provision. No – student loans are not treated as earned income. The contribution limit mentioned is a "total IRA limit," so if you’ve already contributed to a Traditional IRA this year, deduct the amount contributed from the amount you can invest in a Roth IRA to determine the amount you can still contribute.

  • If you don’t have $3,000 to contribute each year, you can contribute what you can. There’s nothing wrong with only contributing $500 or $1,000 to a Roth IRA if that’s all you can do. When married and you don’t have earned income, as long as your spouse has earned income, you can still contribute to a Roth IRA for yourself! In this case, your spouse would have to have adequate earned income to "cover you" - meaning - that if your spouse earned $6,000 in a year, legally, $3,000 could be contributed to each of the individual’s IRAs because there was the equivalent of $3,000 worth of earned income for each spouse.

  • There are income restrictions on the Roth. If you are single, your income must be less than $95,000 (MAGI - modified adjusted gross income) in order to be eligible to fund the $3,000 maximum amount. Income above that allows for reduced contributions until the income exceeds $110,000 MAGI - at that point, the person is no longer eligible to contribute. For married couples (in 2003), the income guidelines are $150,000 MAGI (household earnings less than that allow for full contribution) - MAGI household income over $160,000 disqualified the couple from Roth IRA eligibility (individuals with income that are ineligible for the Roth IRA can still contribute to a Traditional IRA (although without the tax deduction). These amounts are adjusted for inflation.

  • To start a Roth IRA you could go to just about any financial institution (banks, insurance companies, etc.) - for most people that understand the way a Roth IRA works ("a basket"), no load mutual fund companies offer the most options with the fewest fees (sales commissions/loads, etc.). Most mutual funds companies require a minimum investment to start a Roth IRA (typically between $500 and $2500 - companies like Vanguard & Fidelity fall within this range). Many companies like Vanguard allow an investor to start an IRA account with less money ($1,000) than a non-IRA account ($3,000). There are a few mutual fund companies that will allow you to start a Roth IRA with $0 as long as you set up an automatic investment of $50 (or more) per month. These include some of the more notable mutual fund companies such as: T Rowe Price, TIAA-CREF, and Ariel, The Vanguard Group , Fidelity Investments.

  • Early withdrawals (withdrawals before the age of 59½ ) from a Roth IRA are tax-free and penalty-free if they satisfy the five-year holding requirement or the money is used to cover qualified first-time homebuyer expenses of up to $10,000, or if the taxpayer becomes disabled before age 59½ or dies. In addition, other special circumstances could include qualified higher education expenses, medical expenses that exceed 7.5% of adjusted gross income, etc. A tax specialist would be the best person to talk to about the tax treatment of early IRA withdrawals.