Roth Ira Ira Non-Retirement Stocks Bonds Where To Invest What Roth IRAs Made Easy

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Roth IRAs Made Easy

What are Roth IRAs, and how do they work?

They are part of the Individual Retirement Account (IRA) family. They have a special place in that family because they are fully tax-free if you follow the basic rules. We’ll get to those rules in a moment.

Roth IRAs are like a special member of your retirement planning family, similar to a trusty dog. They can faithfully tend your retirement “kitty” while keeping the tax wolf away from the door. But, just like any dog, they can bite if you don’t know how to treat them.

So, here are a few ground rules to set up your Roth IRA to be a happy pet.

1. Make sure you’re eligible.

Qualifying income: You qualify if you have earned and taxable U. S. income from any of these sources: salaries, wages, tips, professional fees, bonuses, commissions, self-employment income, non-taxable combat pay, military differential pay or taxable alimony. (Unfortunately, investment and rental income do not qualify.)

Also, your income must be under certain levels to qualify. For a 2011 contribution, (made through April 16, 2012) your income must not exceed the following:

Single: Modified Adjusted Gross Income (MAGI) needs to be under $107,000, with a phase-out range going up to $122,000 for partial contributions.

Married Filing Jointly (MFJ): joint income needs to be under $169,000 MAGI, with a phase-out range going up to $179,000.

Head of Household or Married Filing Separately who did not live with spouse during the tax year: $107,000 MAGI with same phase-out range as Single.

Married Filing Separately who did live with spouse during the tax year: Cannot contribute if you have over $10,000 in earnings. Reduced amount below that.

Your Modified Adjusted Gross Income is the Adjusted Gross Income (AGI) from your tax return, adjusted by things like student loan interest deductions, rollover conversions, and foreign income. Many people don’t have much of those, and can just use the AGI from their tax return.

2. How to keep your Roth IRA tax-free

Hold it at least five years and until age 59 or later. Remember, IRAs are for retirement, so it’s best to nurture them until your later years.

If you really need to use the money before you’ve qualified for the tax-free status, you can take it out under various hardship clauses. Some of these exceptions include tapping into the IRA for a first time home purchase (up to $10,000 of IRA money you’ve held 5+ years), a disability, paying qualified educational expenses (tuition, books, school fees), or paying for health insurance if you’re out of work.

You can also withdraw IRAs under the Substantially Equal Periodic Payment (SEPP) rules. Get help if you want to do this, as it can be tricky. There’s a potential bite from the IRS if you get it wrong.

You can always take your contributions out at any time without penalty or taxes, just not your earnings. For a complete list of ways to withdraw Roth IRA money without penalty, check the IRS Publication 590 or the book Roth IRAs Made Easy.

What’s the “bite” if you take the money out early? It’s a 10% penalty on your Roth IRA earnings, plus payment of taxes.

3. Know when, what and how much you can put into your Roth IRA.

If you qualify, you can put in the smaller of: your annual earned and taxable compensation OR the IRA limit for that year. You can never contribute more to an IRA than you’ve earned (or will earn) for that calendar year.

The annual IRA contribution limits are the same for both Traditional and Roth IRAs. For 2011, it’s $5,000 for people under age 50 and $6,000 for those age 50 or more. Each year, the government announces the IRA contribution limits for that year, and they tend to increase gradually over time.

There is a 15 month window for contributions for any year. The window starts opening on January 1 of the year and closes on April 15 (or tax-filing date) of the next year. For example, for the calendar year 2011, you can make a contribution starting January 1, 2011 and up until April 16, 2012.

What types of investments can you put in? Use most any type, such as mutual funds, stocks, bonds, Certificates of Deposit (CDs), Exchange-Traded Funds (ETFs), and more.

A Roth IRA can be a wonderful way to save for your future. It can provide you with truly tax-free earnings-a potential savings of thousands of dollars over many years.

In addition to that benefit, Roth IRAs don’t have any Required Minimum Distributions (RMD). Most employer retirement plans and other IRAs do require that you start taking your money out (and get taxed on it) when you turn 70 1/2. Roth IRAs are contented retirement pets that will happily wait until you’re ready to use them.

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