Roth individual retirement accounts let you sock away after-tax dollars so, when you're wealthy and retired, you can get your money out tax-free. With a traditional IRA, you get a deduction for your contributions, but all your withdrawals count as taxable income. There are some limits to Roth savings, and not everyone's eligible to take advantage of them.
You can't save more in a Roth IRA each year than the annual limit. As of 2013, the IRS caps your contribution at the smaller of $5,500 or your compensation for the year. Compensation counts as earned income, just like a paycheck, taxable alimony or your self-employment profits. For example, you can't contribute if you didn't work during the year and you were getting by with investment income or gifts.
Savings for Spouses
The contribution limits are separate for each person, even if you're married. For example, in 2013, you can each deposit up to $5,500 for a total of $11,000, assuming you're both eligible. Plus, if you're married filing jointly, you can share compensation with your spouse. So, you can use an IRA even if you're not the breadwinner in the family. But, if you're married filing separately, you can't take advantage of this exception.
You won't get a tax deduction for Roth contributions, so you won't save money there. But, once the money's there it grows tax-free; you don't have to cut into your gains to pay your taxes. Over a few decades, this could save you tens of thousands of dollars. For example, if you invest $5,500 when you're 30, average a 7 percent return per year and pay 25 percent in taxes, with a taxable account you'll end up with $32,971 when you're 65. But, if you put that money in a tax-sheltered Roth, you'll get $58,721.
Perhaps the best part of the Roth is you don't have to give Uncle Sam a cent of any qualified withdrawals, including your earnings. You won't be able to do that until you're 59 1/2, permanently disabled, or paying for a first home. The Roth also has to be at least five years old. The savings depend on your tax rate in retirement: The higher it is, the greater the savings will be.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."