Roth IRA Rules (in Plain English)

A Roth IRA is not an investment. Rather, it’s a type of investment account, in which you can invest in any number of different things (stocks, bonds, mutual funds, etc.).

What’s unique about a Roth IRA is that you are not taxed on the interest, dividends, or capital gains in the account. Provided that you meet a few requirements (discussed below), everything that comes out of a Roth IRA is tax-free.

Note: This is in contrast to a traditional IRA. With a traditional IRA (if you meet certain requirements) you receive a deduction when you put money in, but everything is taxable as income when it comes out.

• Related resource:  Tax Diversification Roth IRA vs. Traditional IRA.

Opening a Roth IRA

There are numerous brokerage firms with which you could open a Roth IRA. For the most part, where you open an IRA won’t have much impact on what investments you have access to. As a result, I’d suggest focusing on low costs and good customer service.

My suggestion for most circumstances is Vanguard. You can see my Vanguard IRA Review here.

Roth IRA Contribution and Income Limits

For 2010, the maximum contribution to a Roth IRA is $5,000 ($6,000 if you’re age 50 or over). However, your eligibility to make a maximum contribution depends upon your income:

• If you’re single, you can make a full contribution to a Roth IRA if your 2010 Modified Adjusted Gross Income is less than $106,000.
• If you’re married filing jointly, you can make a full contribution to a Roth IRA if your 2010 Modified Adjusted Gross Income is less than $167,000.

Roth IRA Conversions

A Roth IRA conversion occurs when you take money out of a traditional IRA (or other tax-deferred IRA, such as a SEP) and move it to a Roth IRA. Depending upon a few factors, such as how you expect your tax bracket in retirement to compare to your current tax bracket, this move may save you a good deal of money.

Related resources:

• 2010 Roth Conversion Rules
• Should I Convert my Traditional IRA to a Roth IRA?

Taking Money Out of a Roth IRA

With the exception of amounts converted from a traditional IRA, contributions to a Roth can be withdrawn free from tax and penalty at any time. To avoid penalty and tax on withdrawals of earnings, you’ll have to jump through a few hoops.

Related resources:

• Roth IRA Withdrawal Rules
• Tax Planning in Retirement