What is a Roth IRA?

What is a Roth IRA and how does a Roth IRA work? Those are a few questions you probably have after hearing about the plan and how it can actually be a much better choose than traditional 401k plans or IRAs.

How Do 401ks and IRAs Work?

401k’s and traditional IRA’s work like this, you invest part of your income into the plan. This money is tax deferred, meaning you do not have to pay taxes on it. The money can then grow tax deferred for years until retirement.

Eventually when you do retire you can take the money out and only then do you have to pay taxes on it.

How Does a Roth IRA Work?

A Roth IRA is very similar to a traditional IRA and a 401k, only it switches things around a bit.

When you invest a portion of your income into a Roth IRA that money cannot be written off on your taxes. So you do pay taxes on the money that you invest.

However the money can still grow tax deferred and when you eventually retire and take the money out that money (including the Interest) will not be taxed.

When Would You Use a Roth IRA?

If you do the math you will find that all other factors being equal you will receive the same amount with an IRA then you will with a Roth IRA. The difference lies in your tax rate.

If your tax rate is low now but you believe it will be higher in the future then it makes sense for you to pay your taxes now and avoid paying them in the future. In this situation a Roth IRA is the better choice.

Another reason why you would want to invest into a Roth IRA is if you are a highly compensated employee. If you fit into this category you may have restrictions on how much money you can invest into a 401k and an IRA and still receive the upfront tax benefits. This means you will have to pay taxes on the money twice on traditional plans, once when it is deposited and then again when it is taken out.

If this is you then you may be better off just switching to a Roth IRA because there are no upfront tax benefits to the plan to start with. You can avoid any double taxation problems by doing this.

How to Invest Into a Roth IRA

Now that you know what is a Roth IRA you are probably wondering how you can go about investing into one. First of all you have to meet the Roth IRA Eligibility Requirements.

If you do then you just have to find a broker to set up your account for you. Here is a good overview on how to start your Roth IRA.

http://www.stocks-simplified.com/start-Roth-IRA.html

Now that You Know

Now that you know, what is a Roth IRA you know if it is worth your while or not. Not everyone will benefit from the plan, but if you could, then consider setting one up.

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