Start using a Roth IRA to grow your retirement nest egg.
Money Girl
272 MG Your Guide to the Roth IRA, Part 1
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This is the first episode in a two-part series about the Roth IRA. Today we'll cover what it is, who can have one, and the withdrawal rules. Then in part two, you'll find out when you should opt for a Roth IRA. The types of investments a Roth is ideally suited for and where to get one. IRA is short for individual retirement arrangement, and it's a special kind of account that allows you to save and invest for retirement while getting some very nice tax breaks. There are two main types, a traditional IRA and a Roth IRA. When you contribute money to a traditional IRA, it's generally tax deductible. That means you don't pay tax on the money you put in the account, which lowers your tax bill in the current year. Instead, you're allowed to defer taxation on both contributions and earnings until you make a withdrawal during retirement. With a Roth IRA, you have to pay tax up front on your contributions. However, the account grows completely tax-free. That means you never pay tax on your investment earnings when you pull money out during retirement. There are other differences between these accounts, but the major distinction is how and when your contributions and their growth are taxed. Again, with a traditional IRA, money is taxed when you withdraw it, and with a Roth IRA, money is taxed before you put it in. An IRA itself is not an investment. It's just a special type of tax-advantaged account. This concept trips up a lot of people who think that an IRA is only for those who want to invest in the stock market. Think of an IRA like an umbrella that shelters what's underneath from taxes. What you put under your IRA umbrella is up to you and there's a wide range of choices. For instance, if you're very conservative, you could choose CDs, treasuries or bonds. For more growth, you could opt for index mutual funds or exchange traded funds. And if you like a more aggressive approach, you can choose individual stocks or stock mutual funds. There are even self-directed IRAs that allow you to own real estate or businesses inside an IRA, but we're just going to stick to the basics in this podcast. How much you can contribute to an IRA is determined by the IRS each year. For 2012, you can contribute an amount equal to your earned income up to $5,000. If you're age 50 or older, you can contribute up to $6,000. For instance, if you earn $3,000 from a part-time job, you could contribute a maximum of $3,000 to an IRA. But if you're younger than 50 and make $100,000 in 2012, you're still limited to IRA contributions of $5,000. You can make contributions to a traditional IRA, a Roth IRA, or to both in the same year as long as you don't exceed your total allowable limit. For instance, you could contribute $2,000 to a traditional IRA and $3,000 to a Roth. You can even contribute to an IRA if you participate in a retirement plan at work. The deadline for IRA contributions is the tax deadline in the following year, so you have until mid-April of 2013 to make IRA contributions for 2012. Now that you know the Roth IRA basics, let's cover the rules about who can have one. I love learning and anything that makes learning easier. If you're a parent and your child needs some homework help, then IXL is a right for your family. IXL is an online learning program for kids covering math, language arts, science, and social studies. IXL has interactive practice problems for topics from pre-K to 12th grade, and everything is organized by grade and subject. As kids practice, they get positive feedback, awards, and explanations for wrong answers. IXL figures out what your kids need more help with and recommends more topics to practice. Their videos, lessons, sample problems, and learning games too. 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Head over to dickies.com and use the promo code Workwear20 at checkout to save 20% on your purchase. It's the perfect time to experience the quality and reliability that has made Dickies a trusted name for over a century. The $5 meal deal at McDonald's means you get to pick between them a double or a chicken. Mmm, then get a small fry, a small drink, and a four-piece McNuggets. That's a lot of McDonald's for not a lot of money. Get the $5 meal deal today. Prices and participation may vary for a limited time only. Now, back to who's eligible for a Roth IRA. Unlike a traditional IRA, there are income limits on who can make a Roth IRA contribution. The restrictions can change from year to year, but here are the rules for 2012. If you file taxes as a single and your modified adjusted gross income is higher than $125,000, you cannot contribute to a Roth IRA. When you earn from $110,000 to $125,000, you can still contribute, but the amount is phased out or reduced. And if you're married and filed taxes jointly, you cannot contribute to a Roth IRA when your household's joint modified adjusted gross income exceeds $183,000. And when you earn from $173 to $183, your contribution total is reduced. If your income is too high to make a Roth contribution, but you have a traditional IRA, you can convert it into a Roth IRA. Since money in a traditional IRA was never taxed, doing a Roth conversion means that you have to pay income tax on the full amount that you convert. You still cannot make new contributions to a Roth IRA when your income is too high, but you enjoy the accounts tax-free growth. You may be wondering how the Roth IRA stacks up against a traditional IRA when it's time to take money out. The Roth definitely offers more flexibility. With a traditional IRA, withdrawals you make before age 59 and a half are generally subject to ordinary income tax plus a 10% early withdrawal penalty. With a Roth IRA, you can withdraw your contributions at any time without having to pay income tax or a penalty because you already pay tax on them. However, your growth in the account, which is the money that your contributions earned, has not been taxed. So withdrawing any amount of earnings before age 59 and a half means they're generally subject to income tax plus the 10% penalty. Another major distinction between these accounts is that a traditional IRA requires you to start taking money out at age 70 and a half, whether you need it or not. But a Roth does not impose any minimum distributions, which means you can leave the money in the account as long as you want or easily pass it on to your heirs. As you can see, traditional and Roth IRAs both have advantages that can work in your favor depending on your financial situation and goals. In part two of this series, we'll take a closer look at who gets the most benefit from having a Roth, the best places to open one, and which investments allow you to save the most on taxes when you own them inside a Roth IRA. Have you signed up for the free money girl newsletter yet? That's a great way to get more money tips and advice delivered straight to your inbox. Also, if you're not already subscribed to this podcast on iTunes, that's how most people get the show. I'm sure you know that iTunes is a software from Apple that's free to download and subscribing to the podcast simply means you'll automatically get each new weekly episode sent to your iTunes library as soon as it's published on the web. If you have money questions or suggestions for future show topics, be sure to email me at money@quickendertietips.com or post them on the money girl Facebook page. I'm glad you're listening to change. That's all for now, courtesy of Money Girl, your guide to our richer life. 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