What Is a Roth IRA?

Roth IRA's are tax-favored financial vehicles that enable investors to save money for retirement. 

They differ from traditional IRA's in that taxpayers cannot deduct contributions made to a Roth. 

However, qualified Roth IRA distributions in retirement are free of federal income tax and aren’t included in a taxpayer’s gross income. 

That can be advantageous, especially if the account owner is in a higher tax bracket in retirement or taxes are higher in the future.

A Roth IRA is subject to the same contribution limits as a traditional IRA ($5,000 in 2012).

(The maximum combined annual contribution an individual can make to traditional and Roth IRA's is $5,000 in 2012.) 

Special “catch-up” contributions enable those nearing retirement (age 50 and older) to save at an accelerated rate by contributing $1,000 more than the regular annual limits.

Another way in which Roth IRA's can be advantageous is that investors can contribute to a Roth after age 70½ as long as they have earned income, and they don’t have to begin taking mandatory distributions due to age, as they do with traditional IRA's.

However, beneficiaries of Roth IRA's must take mandatory distributions.

Roth IRA withdrawals of contributions (not earnings) can be made at any time and for any reason; they are tax-free and not subject to the 10% federal income tax penalty for early withdrawals. 

In order to make a qualified tax-free and penalty free distribution of earnings, the account must meet the five-year holding requirement and you must be age 59½ or older. 

Otherwise, these withdrawals are subject to the 10 percent federal income tax penalty with certain exceptions which include death, disability, medical expenses in excess of 7.5 percent of adjusted gross income, higher education expenses, and to purchase a first home (up to a $10,000 lifetime cap).

However, these withdrawals would be subject to ordinary income tax.

Keep in mind that even though qualified Roth IRA distributions are free of federal income tax, they may be subject to state and/or local income taxes. 

Eligibility to contribute to a Roth IRA phases out for taxpayers with higher incomes.

The chief advantage of the Roth IRA is obvious: the ability to have investment earnings completely escape taxation. The advantage comes at a price, though: you don't get a deduction when you contribute to the Roth IRA.

So which is more important? It depends on your personal situation, and also on what assumptions you want to make about the future.

You can do lots of fancy analysis, but the bottom line is that most people are better off in the Roth IRA, than not, again depending on each individuals circumstances.

If you are considering Retirement Planning, call for a free consultation today.