The array of financial products and account types available is enough to confuse anyone. However, with some solid background information, distinguishing among different financial instruments and knowing how to use them becomes easier. Understanding how a Roth IRA relates to mutual funds is fairly straightforward, once you examine the basics of each financial product.
Roth IRA Basics
A Roth IRA is a type of tax-advantaged retirement savings account and is regulated by the IRS. Funds inside of a Roth IRA grow tax-deferred. That means that no taxes are paid on interest, dividends or capital gains that occur inside the account. Upon retirement, funds can be withdrawn from a Roth IRA tax-free. However, if earnings are withdrawn before the account owner reaches age 59 1/2, those funds may be subject to a 10 percent tax penalty.
Mutual Fund Basics
A mutual fund is a financial investment vehicle that pools together the money of several investors. This pool of dollars is then invested according to the fund's prospectus, which details how and in what manner the mutual fund's money will be invested. There are numerous types of mutual funds, and they invest in a wide range of securities. Actively managed funds are invested by professionals who make ongoing decisions about how and where to buy and sell securities. Passively managed funds are invested in an index or other pre-determined basket of securities.
Roth IRA Investments
A Roth IRA is an account type and not an investment itself. A taxpayer may open a Roth IRA at any qualified financial firm. The Roth IRA can then be used to house whatever assets are allowed by both the IRS and the custodian of the account. Stocks, bonds, CDs and mutual funds are commonly held within Roth IRA accounts. Other assets, such as real estate, may be held within an IRA as well. Account holders may buy, sell or change the make up of investments within the account as often as they desire.
Mutual Funds Inside of a Roth IRA
Mutual funds are one of the types of investments that may be held within a Roth IRA account. They function in the same manner as funds held in any other brokerage account. All capital gains and dividends are passed through to the fund owner. However, because the mutual fund is inside of the Roth IRA, no taxes are due on those distributions. Shares of mutual funds may be bought, sold or exchanged according to the fund company rules and the rules of the financial company holding the account.