Feb 11th, 2008
Working Backwards: What’s a Roth IRA?
A Roth IRA is a variation on the previously mentioned traditional IRA. It is named for its chief legislative sponsor, Senator William V. Roth, Jr. of Delaware and was established in 1998. In a Roth IRA, contributions are made with post-tax dollars (unlike a traditional IRA, where contributions are in many if not most cases pre-tax). Provided the rules are followed (primarily holding period and age), earnings and withdrawals are free of taxation. As long as the account is open at least five years and the account holder is age 59 1/2 or older, the terms allowing tax free withdrawals are made. The Roth IRA allows identical contributions to a traditional IRA per year, with catchup provisions for those 50 and older. One of the less acknowledged differences between these two types of IRAs is the mandatory retirement age: 70 1/2 for the traditional IRA, but non-existent for the Roth. Income limits for eligibility mean not everyone can open a Roth IRA; almost anyone (as long as they have earned income) can open a traditional IRA.
It can be tricky for some investors to choose between a Roth IRA and a traditional IRA. If you cannot currently get a deduction with a traditional IRA, I think the choice is clear that the Roth would be a better deal; however, if you can get a deduction with the traditional IRA, the choice becomes more difficult. In some cases, the only way people can afford to put money into an IRA would be using the Traditional IRA–the tax deduction can be significant. However, if you believe you will be in a tax bracket that is close to if not higher than your current one in retirement, the Roth can be a huge bargain. Personally, I think the Roth IRA is one of the greatest inventions since sliced bread!
[...] her purposes with this lump sum of money, Chris would seem to be best served by a Roth IRA. She meets the income qualifications and already has a 403(b) plan which she contributes to; she [...]