Roth IRAs - Converting Roth IRAs - How do Roth IRAs work?

What is the best IRA to set up? Individual Retirement Accounts (IRAs) were set up by the IRS as a way for people to save for retirement outside of corporate run pension or retirement or 401K plans. With an IRA, the individual contributes money to it and owns it in his or her own name. When you start withdrawing funds from your IRA (after age 59) you pay taxes on your withdrawls. Unless you have a Roth IRA. Roth IRAs are funded with AFTER TAX dollars, but the earnings and withdrawls are tax free, allowing your money to grow over the years while you avoid capital gains taxes on that growth. Not everyone can contribute to a Roth IRA. Joint filers with earned income below $160K and single filers with earned income below $110K are eligible.

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In your Roth IRA account, you can invest in mutual funds, stocks, bonds and/or treasuries, and CDs. Roth IRAs are also more flexible, allowing you to take out contributions (but not gains) whenever you need to without any taxes or penalties (after all, this is YOUR money that you contributed after already paying taxes on it). After age 59 1/2, assuming the account has been established for 5 years or more, you can withdraw the gains without taxes or penalties. You can also withdraw money in the case of death, disability, or first time home purchase (up to $10K). There are NO mandatory distributions, meaning you can allow the money to grow as long as you like during your retirement years without being forced to withdraw it, as is the case with traditional IRAs. Any early withdrawls of earnings or gains will be taxed at normal income tax rates (not long term capital gains rates) and you will pay a 10% penalty fee.

Contributing to a Roth IRA

For 2005 the contribution limit is $4000 ($4500 if you are over 50). You can also rollover assets from traditional IRAs if your gross adjusted income is less than $100K - but you pay income tax on the rollover amount during the conversion process to gain the benefit of no future taxes on gains and withdrawls from the Roth IRA. For a traditional IRA, the assumption is that your income and tax rate will be lower in retirement, so your withdrawls will be taxed at that future lower rate rather than todays higher rate when you are working and earning more. But if you believe your income and tax rate will be the same or higher in the future, Roth IRAs make more sense since you pay the taxes now and all earnings grow forever tax free. Roth IRAs for children are especially valuable. If a child has earned income from working, they can put that into a Roth IRA and allow it to grow tax free for decades. It is hard to think of a better investment opportunity than that!

Setting up a Roth IRA

You can set up a Roth IRA easily through most investment companies like Vanguard, Fidelity, or T Rowe Price. Most banks can also help you set up a Roth IRA. Always check what kind of annual fees your Roth IRA provider charges. Contributory Roth IRAs for 2005 need to be funded by April 15, 2006 - the contribution limit for 2005 is $4000. Conversion IRAs must be setup by 12/31/2005. You can set up Roth IRA online at Fidelity.com or Vanguard.com. First confirm that you are eligible for a Roth IRA (earned income above $3000 and modified adjusted income below the maximum of $110 or $150K), then decide how much you will invest and select a provider. If you already have a brokerage account somewhere (like Fidelity), that makes it easy. Just fill out their paperwork and it will be set up for you.

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