The Roth IRA is an individual retirement account with some very interesting tax benefits. Specifically, an individual can withdraw contributions at any time tax-and-penalty free and the individual can withdraw earning tax-and-penalty free after age 59 and a half. If a person needs to withdraw earnings prior to age 59 and a half, then the person will likely be assessed a 10% penalty. However, said penalty will usually be waived if the individual is a first-time home buyer or if the individual has become disabled.
The reason qualified withdrawals are not taxed is because Roth IRAs are funded with after-tax dollars. Using an example, let’s say that your employer pays you a salary of $5,000 a month. Your hypothetical tax bracket is 25%. Therefore, you bring home $3,750. And now you fund your Roth IRA with your take-home-pay. As a result, since you funded the Roth IRA with after-tax-dollars, you don’t have to pay taxes as the money grows or when you take withdrawals.
For tax year 2016, the max that you can contribute is $5,500 if your under the age of 50 and $6,500 if you’re 50 or older.
If your filing status is Single and you earned less than $117,000, you can contribute the max of $5,500.
If your filing status is Single but you earned between $117,00 and $131,199, then the amount that you can deduct starts to phase out.
If your income is more than $132,000, then you can’t contribute to a Roth IRA.
Retirement planning is an essential part of personal finance. Definitely leverage available tax-shelters such as the Roth IRA or the Traditional IRA. The difference between the two is that contributions to the Roth IRA are post-tax while contributions to the Traditional IRA are pre-tax. Further, withdrawals from a Traditional IRA are taxed as taxes were never paid as contributions were pre-tax.
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