Roth IRAs Key Terms

Understand the terminology associated with Roth IRAs

By Mary Yamin-Garone

A Roth IRA offers individuals a benefit that is not offered with other traditional individual retirement accounts. Meeting the specific requirements associated with Roth IRAs guarantees that all of the account holder’s earnings will be tax-free when either they or their beneficiary withdraws those earnings. This type of IRA also keeps individuals from having to pay a penalty for early distribution on particular withdrawals. Understanding some of the key terms associated with Roth IRAs will help you make an informed decision when it comes to investing your money.

Traditional IRA

Traditional IRAs differ from Roth IRAs in that their earnings and deductible contributions are tax-deferred. Account holders are not required to pay taxes until they withdraw their funds. Usually, the withdrawal is made after the individual retires and is in a lower tax bracket. There may be IRS-imposed penalties for early withdrawal. Roth IRA earnings are tax-free if the contribution requirements are met. Contributions, however, are taxed.
Try: State Farm Insurance compares traditional IRAs with Roth IRAs.

Roth IRA conversion

Sometimes a Roth IRA proves to be a better means of saving than a traditional individual retirement account. In those cases, individuals have the option of converting all or a portion of their IRA monies into a Roth account. This conversion is done by withdrawing funds from the traditional account and paying taxes on that money. The remaining funds are then used to establish a Roth IRA.
Try: AARP offers basic information about Roth IRAs.

Estate planning

Estate planning establishes legal arrangements or procedures for distributing an individual's assets at the time of death or if he or she becomes incapacitated. Roth IRAs - and their beneficiaries - often are part of that planning. That is why it's important to be specific about your plan's beneficiary.
Try: Roth IRA Advisor explains the relationship between Roth IRAs and estate planning.

Contribution limits

Generally, contribution limits for Roth IRAs are comparable to those of traditional retirement accounts. In 2007, individuals could contribute up to $4,000 in their Roth IRAs. The maximum contribution was increased to $5,000 in 2008. Those older than age 55 may contribute another $1,000. At no time, however, may contributors put in more money than they earn.
Try: IRA regulations, including contribution limits, can be found at Bankrate.com.

Income limitations

Unlike traditional accounts, there are income limitations for Roth IRAs. An individual's eligibility to open one of these accounts depends on his or her income tax filing status and modified adjusted gross income.
Try: Fidelity.com provides income guidelines for Roth IRAs.

Distribution guidelines

All Roth IRA distributions are tax-free until an individual withdraws all of his or her "regular" contributions. From that point on, "conversion" contributions are withdrawn. Any subsequent withdrawal is taken from the account holder's earnings. These withdrawals also are tax-free if the individual is older than 59 and five years have passed since the IRA was opened. In all other cases, distributions are taxable and subject to penalties for early withdrawal.
Try: Fairmark features a quick overview of Roth IRAs.