The basics of the Roth IRA are pretty simple. After-tax dollars are contributed to an account that grows tax-deferred until retirement. After age 59.5, distributions are tax-free. The reasons for starting a Roth IRA are many.
Following are 5 reasons why you may want to start a Roth IRA – right now.
- You can fund your 2013 Roth IRA up until April 15th of this year. To count for 2013, contributions must be posted to your account by that date. FYI – dropping off a check with your financial advisor at 4:00 p.m. on the 15th doesn’t count. Contributions are limited to $5,500 each year + an extra $1,000 if you are age 50 or older. A married couple, age 50, could contribute up to $26,000 to Roth IRAs for 2013 and 2014 between now and April 15th . If you have the cash, you can even fund both your 2013 and 2014 Roth IRAs right now and be done for the year.
- Principal can be withdrawn at any time. IRAs are great for retirement, but what if you need that money before then? Unlike traditional IRAs, the Roth allows for tax and penalty free distributions of your “basis” or principal. What’s more, the principal comes out first. If you contribute $5,500 to a Roth IRA today, but need the money at some point before age 59 ½, it’s available as a tax-free withdrawal of basis.
- IRA assets are exempt on most financial aid forms. If you are a parent filling out financial aid forms for your college student, the money you have in IRA accounts, including the Roth IRA, are exempt assets on the Free Application for Federal Student Aid or FAFSA form. If you contribute $11,000 right now ($5,500 for 2013 and $5,500 for 2014) those dollars are exempt from the financial aid calculation. If you are married and age 50 or older, you may be able to exempt up to $26,000 through your IRAs.
- Contributing to a Roth IRA starts the 5-year clock. To enjoy tax-free status, distributions from a Roth IRA have to be qualified distributions. To be a qualified distribution two tests must be met: 1) you must be over age 59 ½, and 2) The Roth IRA needs to be 5-years old. The 5-year clock starts ticking on January 1st of the year you make your first deposit. If you contribute to a Roth IRA for 2013 right now, the clock effectively started on January 1, 2013.
- Roth IRAs are a great gift for your kids or grandkids. Anyone with “earned income” can contribute to a Roth IRA if their income is below certain limits. The IRS doesn’t care where the money came from, only that the IRA owner qualifies to make a contribution. If your kids made money at a job, they are eligible to contribute up to 100% of their income or $5,500 max to a Roth IRA. The tax benefits offered by the Roth might not be important to your 16-year old, but remember Roth IRAs are exempt on the college financial aid forms. With a Roth IRA they can accumulate assets in their name with out affecting their financial aid award. Later the basis can be distributed tax and penalty free, if the money is needed to pay for college. It’s only the investment earnings that must stay in the IRA until retirement.
IRAs can be complicated and have various limits and restrictions. For more information on those limits, email me with the subject line “Roth Right Now”. Or to go straight to the source, visit www.IRS.gov and download publication 590.
On April 15, the window for making a 2013 contribution will close. If you’re thinking about starting a Roth IRA or want to make the most of an existing IRA, the time to do it is right now.
Disclosure: A Roth IRA distribution is qualified if you have had the account for at least 5 years and/or the distribution is made after you have reached age 59 ½, because of your total and permanent disability, in the event of your death or for first-time home buyer expenses. Distributions made prior to age 59 ½ may be subject to a federal income tax penalty. If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings. We suggest that you discuss tax issues with a qualified tax advisor.
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