Roth IRAs, first available after legislation allowing them was passed in 1997, offer an alternative way to save for retirement. Instead of getting a tax break for contributions, you save after-tax dollars and get the big tax break when you're taking withdrawals during retirement. They're usually best for people who pay a lower tax rate now than they expect to pay during retirement.
Not everyone gets to use Roth IRAs. Instead, only people with modified adjusted gross incomes below certain annual limits can contribute at all. For example, in 2013 you're ineligible if your MAGI exceeds $188,000 and you're married filing jointly or $127,000 if you're single. Plus, you have to have compensation -- income you receive from working, self-employment or taxable alimony. There are no age limits with regard to who can contribute.
Though you might not think of the IRS as a hip organization, it does keep up with the times by regularly adjusting the annual contribution limit for inflation. For example, in 2013, the limit went up from $5,000 to $5,500 for people under 50 years old. When you reach 50, you get to add an extra $1,000 catch-up contribution. If your compensation is less than these limits, however, you need to use that as your limit instead. For example, if you only have $3,000 in compensation, that's your limit -- not $5,500. However, if you've tied the knot and file a joint return, you can count your spouse's compensation, too.
You don't need to worry about contributing too much and then paying penalties to get your contributions back. No matter when you're taking a distribution, your contributions always come out tax-free. Plus, if you're taking a qualified distribution, you get your earnings out tax-free, too. Qualified distributions require your Roth IRA to be at least five years old. You also need to be either 59 1/2, permanently disabled, taking distributions as a beneficiary of an inherited account or taking out up to $10,000 as a first-time home buyer.
Early Earnings Withdrawals
If you're taking a non-qualified withdrawal, once you've taken out all the contributions, you start dipping into your earnings. The earnings count as taxable income and, unless an exception applies, these also get hit with a 10 percent early withdrawal penalty. There's a small glimmer of hope, though, because if an exception applies, you only have to pay the taxes. These exceptions include a permanent disability, significant medical expenses, health insurance when you're unemployed, higher education expenses and taking up to $10,000 for your first home.
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