What is a Roth IRA?

IRA is an acronym for an Individual Retirement Account. A Roth IRA is similar to a regular IRA, but there are a few key differences. In a Roth IRA, contributions cannot be deducted on a tax return, but later distributions are tax free. The contributor can only deposit earned income into their Roth IRA.

Roth IRA

A Roth IRA is an Individual Retirement Account. You may have heard of an IRA before. A Roth IRA and an IRA are very similar, but they have some distinct features that set them apart.

A Roth IRA has two parts to it: The contributions, which is the money the holder puts into the Roth IRA, and part two is the distributions, which is the money the holder takes out of the Roth IRA. The idea of an IRA is to be for retirement. During the holder’s working years, they’re putting money into the IRA and the money earns interest. The interest is compounded, resulting in even more interest. Later in life, upon retirement, the holder can pull the money out to sustain them throughout the rest of their life.

Let’s go over some different things you need to know about Roth IRAs. Contributions cannot be deducted on a tax return. They’re not going to help you get more money back on your tax return. You might be thinking that’s a negative, but the flipside is that the distributions are tax-free. Even though it doesn’t help you on your taxes, it doesn’t hurt you later. Taxes don’t interfere with the process of a Roth IRA.

Only earned income may be contributed. The contribution limits change; there’s always a limit to the amount of money a holder can put into an IRA. There is a limit on the contribution they can make each year to the Roth IRA. However, that changes mainly due to inflation and the contribution limit is usually higher if the holder is over 50. It’s usually $500 or $1,000 higher than the normal contribution limit.

There is also a point at which contributions can no longer be made. Then, distributions cannot be taken until the holder is 59.5 and the money has been in the account for five years. As long as the holder complies with these rules, they can take all the money out without taxes or penalties. However, if they take the money out too early, they may encounter taxes and/or penalties. There are hardship reliefs from this rule. There’s no penalty if the distribution or the early distribution is due to something like debt, disability, or even a first-time home purchase.



by Mometrix Test Preparation | Last Updated: October 24, 2019