How A Roth IRA Works: A Simple Guide For Retirement Savings

Many people believe they don’t have enough money to save for retirement, but a Roth IRA is specifically designed so that you can contribute whatever you can afford, even if it’s only $50 per month. The Best roth ira investments offers many advantages, such as tax-free growth and withdrawal of contributions (not investment gains), and is an important part of a retirement plan.

What is a Roth IRA?

A Roth IRA is a special type of individual retirement account, or IRA. There are several types of IRAs, including the traditional IRA and the SEP-IRA.

A Roth IRA also has several important features:

Contributions to a Roth IRA may be made on an after-tax basis, meaning that you contribute with money that you have already paid taxes on. This distinguishes the Roth from other types of IRAs, which allow tax-deductible contributions; with those accounts, you contribute with money for which no taxes have been paid. Your investments grow tax-free and can be withdrawn tax-free, assuming certain conditions are met.

How does a Roth IRA work?

Any U.S. citizen or resident with earned income can contribute to a Roth IRA, subject to income limits. You can generally make contributions up to the due date of your tax return, including any extension; this is a major advantage of the Roth compared with other types of IRAs, which have set annual contribution limits or require that you make contributions during the calendar year in which you turn 70½. When you open an account at a bank, brokerage firm or mutual fund company, they’ll provide step-by-step instructions for how to contribute. Most companies that offer IRAs also offer Roth IRAs. Contributions to a Roth IRA must be made in cash.

The money you contribute to your Roth IRA is invested in the manner of your choosing, and all investments (including mutual funds, stocks, bonds and CDs) are eligible for Roth IRAs. Withdrawals of contributions can be taken at any time for any reason without penalty or tax. However, if you take a withdrawal that isn’t a return of contributions (such as investment earnings or withdrawals before age 59½), the withdrawal amount will be taxed as income and may also be subject to a 10% penalty.

What are the pros and cons of a Roth IRA?

The major disadvantages (in descending order) of Roth IRAs include:

Some people don’t understand how a Roth IRA works, and end up contributing too little money to their account. This is especially true in early years, when contributions can be significantly lower than they will be later. Without sufficient contributions, your earnings on the funds will not be tax-free. A Roth IRA is an excellent vehicle for retirement saving because you can contribute whatever amount you can afford, even if it’s less than the maximum allowed by law.