Roth IRA

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What is a 'Roth IRA'

A Roth IRA is an individual retirement plan that bears many similarities to the traditional IRA, but the contributions are not tax deductible and qualified distributions are tax free. Similar to other individual retirement plan accounts, non-qualified distributions from a Roth IRA may be subject to a penalty upon withdrawal.

BREAKING DOWN 'Roth IRA'

A qualified distribution is one that is taken at least five years after the taxpayer establishes his or her first Roth IRA and when he or she is age 59.5, disabled, using the withdrawal to purchase a first home (limit $10,000), or deceased (in which case the beneficiary collects). Since qualified distributions from a Roth IRA are always tax free, some argue that a Roth IRA may be more advantageous than a Traditional IRA.

Named for Delaware Senator William Roth, the Taxpayer Relief Act of 1997 established the Roth IRA. As of the end of 2015, investors held $660 billion in Roth IRA accounts, roughly 9% of total IRA assets.

Eligibility Requirements

Eligibility to contribute to a Roth IRA and permitted contribution amount depends on the individual's tax filing status and modified adjusted gross income (AGI). For 2016, single filers with an AGI under $117,000 can contribute up to the full $5,500 limit ($6,500 for those age 50 or older). Single filers with an AGI over $132,000 are ineligible to make a Roth IRA contribution, while those with an AGI between those two levels can make partial contributions. Married couples filing jointly can make full contributions if the AGI is under $184,000, and those making more than $194,000 are ineligible to contribute.

Who Benefits the Most

Whether or not a Roth IRA is more beneficial than a traditional IRA depends on the tax bracket of the filer, the expected tax rate at retirement and personal preference. Individuals who expect to be in a higher tax bracket in retirement may find the Roth IRA more advantageous since the total tax avoided in retirement will be greater than the income tax paid on the contribution amount in the present. Therefore, younger and lower-income workers may benefit the most from the Roth IRA.

Even those who expect a lower tax rate in retirement can find benefit with the Roth IRA. Many investors simply prefer a tax-free income stream in retirement. The Roth IRA also allows an individual to pass on assets to heirs tax-free upon his death. Required minimum distributions are not a consideration with the Roth IRA. Those who don't need Roth IRA assets in retirement can leave the money to accrue indefinitely. As long as the individual has earned income, he can make contributions to the Roth IRA at any age.

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