Yesterday I wrote about the benefits of the Roth 401K, and mentioned that you can roll the money into a Roth IRA to avoid required minimum distributions. So now I should probably explain what a Roth IRA is and why you should have one.
What Is a Roth IRA
A Roth IRA as an individual retirement account that you can set-up without going through your employer. You can invest the money you deposit in mutual funds and stocks. It’s very similar to a traditional IRA, but with a few key exceptions:
When you fund a traditional IRA, you receive a tax deduction for your contribution. With a Roth IRA, you don’t receive a tax-deduction. However, the contributions and growth are both tax-free when you withdraw them during retirement because you paid the tax on the money you contributed already.
Roth IRA contributions are subject to income limits. If you’re single, the limit is $105,000-$120,000. If you’re married filing jointly, it’s $167,000-$177,000. If your income exceeda the cap, you can still own a Roth IRA, but you can’t contribute to it that year.
No Required Minimum Distributions:
401Ks and traditional IRAs require you to withdraw a minimum distribution every year (except 2009) once you reach age 70 ½. Not with the Roth. You can leave the money there forever. If you pass it on to heirs, they can also leave the money there forever.
Looser Early Withdrawal Rules:
I covered this in a previous post about withdrawing from a Roth IRA. Suffice it to say, you can withdraw your funds for a wider variety of things and with fewer penalties with a Roth IRA. Obviously, it’s still not recommended because you’re depleting your retirement, but it’s easier.
How to Open a Roth IRA
Opening a Roth IRA is simple. Choose a brokerage or mutual fund and tell them you want to open a Roth IRA. You can usually apply online, but will need to submit some signed paperwork. A brokerage will give you more options because you won’t be limited to a single fund family, but it’s a personal decision. You can open a Roth IRA for 2009 until April 15, 2010, so you could actually make double contributions in the year you open it by designating some contributions for 2009 and some for 2010, even though they all took place in 2010.
If you don’t work, but have a spouse who does, you can open a “spousal IRA”. Basically, you can contribute money from any source, as long as your spouse has qualifying income.
Roth IRA Contribution Limits
The contribution limits for a Roth IRA are the same as the limits for traditional IRA: $5,000 for most people, $6,000 for those over the age of 60. This is a total for both traditional and Roth IRAs per person, not per account. So, you and your spouse can contribute $5,000 each to any type of IRA account.
If you exceed the cap and want to open the account, you still can. Simply contribute to a traditional IRA, and then roll it over to a Roth IRA. Starting in 2010, there are no income limits for rollovers, only initial contributions.