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A Roth IRA is a retirement account that is taxed when money is added, but grows tax-free and can be invested in various earning strategies. Withdrawals up to the amount deposited are always tax-free, and penalties exist for early withdrawals. It is recommended for those in a low tax bracket who plan to retire in a higher bracket. Income must fall within a specific range to contribute, and it was created by Senator William Roth.
An IRA is an individual retirement account. IRAs comprise a special class of U.S. retirement accounts that offer varying tax benefits depending on the type of IRA you choose. A Roth IRA is taxed as money is added, which allows it to grow without additional taxes and to plunge tax-free.
A Roth IRA can be invested in a number of earning 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 you currently live in, something that may be a disadvantage for some compared to a traditional IRA. When money is withdrawn from the Roth IRA, however, funds up to the amount put into it are always federally tax-free, and often the entirety of the funds are federally tax-free.
There are also penalties associated with a Roth IRA and withdrawing money early. By retiring before retirement, you may incur both federal taxation and a 10% direct penalty. Fortunately, these penalties aren’t always triggered, as exemptions exist for cases like buying a home or paying for college. There is never a penalty for withdrawing money up to the amount you have deposited into your account, penalties are only incurred when you draw on your earnings.
The Roth IRA is especially recommended for people who are currently in a relatively low tax bracket and plan to retire in a higher bracket. By paying taxes in a low range, say 15%, these people can avoid potentially much higher taxes at their retirement age if their income level rises enough to place them in a higher range, say 40%. With a traditional IRA, the entirety of their earnings – even those they’ve set aside in a 15% bracket – will be taxed at 40% if that’s the bracket they’re 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 huge amounts of money by the time they retire.
To take full advantage of a Roth IRA, your income must be within a specific range, based on your marital status. Once income falls below that level, the amount a person can contribute to their Roth IRA decreases, and once income exceeds a maximum limit, they are no longer allowed to invest money in a Roth IRA.
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 among different groups of people and are one of the most commonly recommended investment strategies for middle-class workers.
Smart Assets.
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