ROTH IRA

By | March 23, 2005

ROTH IRA is a retirement plan where you put in your after-tax dollars and when you retire, you can withdraw from the account tax-free. If you earn less than 95K and single (150K for married) you can contribute a maximum of $3,000 for 2004 and $4000 for 2005. If you’re 50 or older, you can put in an extra $500. Also, when you reach the age of 70 and a half, you are not required to take minimum distributions.

The beauty of the whole ROTH IRA idea is to have your earnings avoid tax when you take them out. There are also some other nice additions to the plan. You can take your contributions out without penalty at any time. Another thing you can do is to take out up to $10,000 without penalty/tax to pay a down payment for a primary home, provided that your plan is opened for 5 years. There is a lot more details you can read here.

I want to talk more about taking advantage of the plan and how that will benefit you. If you qualify, it is very important to set it as a priority to contribute as much as you can, and because the limit is so low, it is best to put in the maximum. In the worst case scenario, if you have absolutely exhausted other options, you can withdraw the original contributions without penalty.

While ROTH IRA does allow the flexibility to withdraw deposits, I strongly suggest you not to do that. Putting funds into the account is like planting money seeds. If you take them out, you give up the opportunity for the seeds to grow and sprout. The end result is you having less money working in your favor.

The sooner you plant the seeds, the sooner it’ll grow. And the more you plant the more you’ll have growing for you. Therefore, it is very important to start early. A $3,000 contribution this year vs. five years from now makes a big difference over time. Assuming 8% average return per year, your $3,000 deposit this year can make you $30,187.97 in 30 years, but starting five years late with the same amount will only net you $20,545.43. That’s a difference of almost $10,000 for holding back five years. Now, if you had been contributing for five years straight, the difference is much more significant.

The bottom line is, if you have no idea what a ROTH IRA is, take the two minutes to read up on it and sign up as soon as you can. You have up until April 15 to make a contribution for 2004. If you’re low income and use the no-money excuse, then you should know that the government is already working in your favor. Any contribution you make will get you a 50% credit (or less depending on your AGI) from the Savings Credit. Having someone else put in half of your contributions, there are no more excuses. This is a benefit for you that will pay you big in the long run.

3 thoughts on “ROTH IRA

  1. Anonymous

    Hi, you have a great blog, lots of useful tips. But I just wanted to make a correction — I’m pretty sure that for Roth IRAs, you can withdraw CONTRIBUTIONS at any time. You don’t have to wait till after five years.

    The five year rule applies to EARNINGS, not contributions.

    So actually, that makes Roth IRAs even more flexible.

    Reply
  2. Abdul Sumar

    Here’s a good explanation from http://www.definerothira.com that will clear up the confusion. You can withdraw money from your Roth IRA up to the total amount of your contributions.

    “Jim makes Roth IRA contribution on March 1st, 2002 for $3000. 6 years later on March 1st, 2008, Jim withdraws $5500 from his account (the principal $3000 + $2500 earnings). Jim’s withdrawal is not qualified because he does not plan to purchase a home for the first time, nor is he disabled, plus Jim is not 59 and 1/2 years old or more. Jim will face a 10% early withdrawal penalty + have to pay income taxes on his withdrawal. If Jim had withdrawn only $3000 from his Roth IRA which equals the total contributions he made, he would not be subject to income taxes nor the 10% early withdrawal penalty. This is because Roth IRAs allow you to withdraw up to the maximum contributions you have made and not any earnings on those contributions. Since withdrew the whole $5500 consisting of $3000 principal + $2500 earnings, he will be penalized.”

    Reply

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