"What is up with the different types of IRA’s?"
After a lengthy discussion about traditional IRA’s, let’s tackle Roth IRA’s. The way I like to look at the Roth IRA is as the reverse of a traditional IRA. As explained in the previous post, with a traditional IRA, you do not have to pay taxes on the contributions, but you do have to pay taxes when the money is withdrawn. With a Roth IRA, it is the opposite. You have already paid taxes on the money you contribute, and you never have to pay taxes on any of the money withdrawn as long as you meet the appropriate criteria.
The power of the Roth IRA is incredible especially if you can leave the money in the account for a very long time. This is all tax free growth. This is one of a very few investments you can make where you do not have to pay any taxes on the growth—EVER (again, as long as you meet the appropriate criteria).
If you also recall, the traditional IRA requires you to begin taking withdrawals once you reach the age of 70.5 primarily because the US government wants to have the ability to tax this money. This is not the case with the Roth IRA. The US government does not care how long you leave the money invested because they won’t be able to tax it anyway. With a vast number of people living into their 90’s, Roth savings are great since you do not have to touch this money until absolutely necessary. Why take withdrawals when you can just let it keep growing tax free?
The same limits on how much can be contributed to a traditional IRA also apply to the Roth IRA. In 2012, you can contribute a maximum of $5000 and for 2013, a maximum of $5500. If you are over 50 then you can also contribute an additional $1000 for 2012 and for 2013.
You may also recall that there are limits on who can contribute to a traditional IRA. There are also income limits on who can contribute to a Roth IRA and these are higher than a traditional IRA. As an unmarried individual, you can make a Roth IRA contribution in 2013 as long as your modified AGI (adjusted gross income) is under $112,000 ($110,000 in 2012). As a married couple, each person can make a fully deductible contribution in 2013 as long as your modified AGI is under $178,000 ($173,000 in 2012). It is possible to make a partial contribution to a Roth IRA if you fall into a certain income range, but will not post on those details to avoid getting into minutia.
Hopefully, after reading this you see why I am such a big fan of Roth IRA’s and that you feel the same way. I did not get into when you can begin withdrawing and all the rules surrounding that. I am assuming that you are making these contributions for long term growth and only plan to use these for retirement as they are intended. I could go on for pages about all the details, potential penalties, exceptions, etc surrounding IRA’s. My focus was to offer the way I think about these investment options and how I have come to understand them. Hopefully by reading this you gained a more complete understanding of these two options and can appreciate the importance in using them when investing for retirement.
Please keep your questions coming. I enjoy reading them all and answering as many as I can.