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What is a Roth IRA?

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  • Written By: Brendan McGuigan
  • Edited By: Niki Foster
  • Last Modified Date: 19 September 2016
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An IRA is an Individual Retirement Account. IRAs comprise a special class of retirement accounts in the United States which give varying tax benefits depending on the type of IRA chosen. A Roth IRA is taxed as money is added to it, which allows it to develop with no further taxation and to be dipped into with no taxation.

A Roth IRA can be invested in a range of gaining strategies, including mutual funds and traditional stocks. When money is first invested in a Roth IRA, it is federally taxed based on the tax bracket one currently inhabits, something that may be a downside for some when compared to a traditional IRA. When money is taken out of the Roth IRA, however, funds up to the amount put into it are always federal-tax free, and often the entirety of the funds are free from federal taxes.

There are also penalties associated with a Roth IRA and withdrawing money early. By withdrawing before retirement, one may incur both federal taxation and a 10% direct penalty. Luckily, these penalties are not always triggered, as there are exemptions for cases such as purchasing a house or paying for college. There is never a penalty for withdrawing money up to the amount one has put into the account, penalties are only ever incurred when drawing on earnings.

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The Roth IRA is particularly recommended for people who are currently in a relatively low tax bracket and anticipate retiring in a higher bracket. By paying taxes while in a low bracket, say 15%, such people can avoid potentially much higher taxes at their age of retirement if their income level increases sufficiently to knock them up into a higher bracket, say 40%. With a traditional IRA, the entirety of their earnings -- even those they put away while in a 15% bracket -- will be taxed at 40% if that is the bracket they are in when they cash out their IRA. With a Roth IRA, however, they pay taxes based on their current bracket at each investment interval, potentially saving enormous amounts of money by the time they retire.

In order to take full advantage of a Roth IRA, one's income must be within a specific range, based on marital status. Once income drops below that level, the amount a person may contribute to their Roth IRA drops, and once income rises above an upper cap, they are no longer allowed to put money into a Roth IRA at all.

The Roth IRA is the brainchild of Senator William Roth (R-DE), a fiscal conservative involved in a number of tax-related bills. Since their inception, Roth IRAs have become very popular amongst diverse groups of people, and they are one of the most commonly recommended investment strategies for middle-class workers.

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anon176861
Post 5

Roth is named after Senator William Roth of Delaware who sponsored it.

anon62728
Post 3

what does the word roth mean?

anon10965
Post 2

When i can withdraw earnings from roth ira without penalty

Moderator's reply: research this fully before making a decision to withdraw funds from your roth ira. check out our article, what is an early ira withdrawal? for more info.

anon7246
Post 1

Can you make a Roth IRA contribution with your credit card, or one of those advance checks that credit cards sometimes offer?

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