A Roth IRA is an individual retirement account. Unlike a traditional IRA or a 401k account, the contributions to a Roth IRA account is not tax deductible. Instead, the distributions during retirement are tax free. This is a big advantage if your tax rate is higher when you retire.
A Roth IRA is a good investment option to parents. There are potential tax advantages over regular retirement accounts. Also, contributions to a Roth IRA can be withdrawn without penalties. As a result, Roth IRA accounts are sometimes used for other purposes like funding a college education.
I considered this strategy at first when I looked into creating a college fund for my son. Parents’ retirement accounts are not included for college financial aid considerations so it will help with his eligibility. I also have the flexibility to keep my money for retirement should he not need it for college. The alternative, a 529 College Fund, is also funded by after tax contributions and grow tax free. However, 529 distributions are limited to college expenses only. Penalties are imposed if used for other purposes. In the end, I decided on opening a 529 College Fund. Among other reasons, I wanted to take advantage of all the tools Uncle Sam has available for saving money and to maximize our savings.
Here are the main rules for Roth IRA:
1. Contributions must be from earned income through actual work compensation.
2. Contributions are limited to $5,000 maximum per year for people under 50 and $6,000 for those older.
3. Contributions can be made up to the tax deadline of the following year. For example, you can contribute for the year 2011 until April 17, 2012 (2012 tax deadline).
4. Contributions are not tax deductible.
5. If one spouse has compensation income, the other spouse is eligible to contribute to a Roth IRA account if the couple files taxes jointly.
6. There is no age limit to participate. Even minors can establish an account granted they have verifiable earned income.
7. You can contribute to both 401k and Roth IRA accounts. Participation in one account does not affect the other.
8. You can make contributions to your Roth IRA after you reach age 70 ½.
9. You can leave amounts in your Roth IRA as long as you live.
10. There are income limits to participants. The 2012 limits are:
- $110,000 – for those filing Single, Head of Household, or Married Filing Separately (not having lived with spouse during the year).
- $169,000 – for those filing Jointly.
- $10,000 – for those filing Married Filing Seperately (and have lived with spouse during the year).
How to open a Roth IRA
Opening a Roth IRA account is easy. You can open an account with your bank and various brokerage or investment companies. You can have multiple accounts as long as your yearly contribution does not go over the limit. Contributions can be setup automatically every month, as a one time payment or whenever you want to during a given year.