Word of the Week 'Roth IRA'


DEFINITION of 'Roth IRA'

Named for Delaware Senator William Roth and established by the Taxpayer Relief Act of 1997, a Roth IRA is an individual retirement plan (a type of qualified retirement plan) that bears many similarities to the traditional IRA. The biggest distinction between the two is how they’re taxed.

Traditional IRA contributions are generally made with pretax dollars; you pay income tax when you withdraw the money from the account during retirement. Conversely, Roth IRAs are funded with after-tax dollars; the contributions are not tax deductible (although you may be able to take a tax credit of 10 to 50% of the contribution), depending on your income and life situation). But when you start withdrawing funds, qualified distributions (see below) are tax free.

BREAKING DOWN 'Roth IRA'

Similar to other individual retirement plan accounts, the money invested within the Roth IRA grows tax free. Other defining characteristics of a Roth:

  • Contributions can continue to be made once the taxpayer is past the age of 70½, as long as he or she has earned income.

  • The taxpayer can maintain the Roth IRA indefinitely; there is no required minimum distribution (RMD) during the account holder's lifetime.

  • Eligibility for a Roth account depends on income.

Establishing a Roth IRA

A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. These include banks, brokerage companies, federally insured credit unions and savings & loan associations.

A Roth IRA can be established at any time. However, contributions for a tax year must be made by the IRA owner’s tax-filing deadline, which is generally April 15 of the following year. Tax-filing extensions do not apply.

There are two basic documents that must be provided to the IRA owner when an IRA is established:

  • the IRA disclosure statement

  • the IRA adoption agreement and plan document

These provide an explanation of the rules and regulations under which the Roth IRA must operate, and establish an agreement between the IRA owner and the IRA custodians/trustee.

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