Understanding the Basics of Roth IRAs

For most Americans saving for retirement isn’t a tax consideration and they are not receiving a matching contribution in their 401(k) plan from their employer. So Roth IRAs more than likely to fit the financial profile of middle class Americans who are saving for retirement. If you’re saving $1,000 a year for retirement in a 401(k) plan with no employer match, your annual tax savings over your working life will not overcome the full taxation of your retirement plan distributions and your Social Security benefits. So you should consider a Roth IRA as an alternative to participating in a 401(k) plan.

Roth IRAs are not deductible, but they do accumulate tax deferred and at the approved time for distributions are tax-free. Roth IRA income is not includable in the provisional test for Social Security benefit taxation. An individual’s annual contribution to a Roth IRA is $5,500. If you are age 50 or older you can contribute an additional $1,000 under the “catch up” provision. There are phase out income ranges for individuals and married couples that can affect contribution amounts, so ask your tax accountant for your modified adjusted gross income. Keep in mind that Roth IRAs are not subject to required minimum distributions. The five-year rule for Roth IRA distributions covers the first 5 years after your first Roth IRA contribution before you can withdraw the earnings in the account tax-free. On the event of death, the funds inside the Roth IRA can pass tax-free to beneficiaries if the five-year holding period is met. Roth IRAs can be a powerful component of your tax diversification strategy. Most Roth IRAs are funded with mutual funds and ETFs.

One last thought worth mentioning: Roth IRAs and HSA accounts are an excellent tandem approach to tax free retirement planning. HSA accounts have the extra benefit of being tax deductible and tax-free withdrawals for medical expenses and insurance premiums like medical, disability, long-term care or even Medicare. The tax-free distributions from HSA accounts are also not includable in the provisional income test for Social Security benefit taxation. Roth IRAs and HSA accounts should be America’s saving combo retirement plan.