Roth IRAs and Taxes

Individual retirement accounts play a vital role in saving enough money to face your golden years in relative comfort. In order to gain the maximum benefit from your IRA you must understand how your retirement account works in your favor and what penalties can be expected if you handle your account incorrectly.

Different rules apply to different types of IRAs, making it important to understand how your specific retirement account should be managed. Roth IRAs do not offer an immediate tax break like traditional IRAs, however there are other tax benefits that can be taken advantage of when you have this type of retirement account.

In order to fully understand how your Roth IRA affects your taxes, consider the following tips.

• Roth IRA contributions are taxed upon contribution, therefore your money can grow tax-free with no taxable penalties when you withdrawal your cash as long as you meet certain guidelines.
• The IRS limits contributions to $5,000 in 2010 ($6,000 if you are 50 years of age or older) if your modified adjusted gross income is less than $176,000 for those married and filing jointly and $120,000 if you file single. Your contributions are also limited to the amount of money you earn. You must use earned income to make contributions, therefore if you earned income is only $2,000 per year, you are limited to $2,000 worth of contributions.
• Contributions to a Roth IRA can not be used to lower your adjusted gross income, which is beneficial in reducing taxable income as well as helping some qualify for certain tax credits or deductions.
• There are little if any special reporting to the IRS with a Roth IRA. Other IRAs require that you report a deduction on your 1040 form when making contributions or when you remove money from the account.
• If your taxes rise over the years, you benefit from a Roth IRA in that you have already paid taxes on your contributions, therefore you will not be hit with a higher tax bracket when it comes time to withdrawal your money.
• You can make contributions at any time prior to the due date of your tax return. For example if you want to make contributions for the 2009 calendar year, you can do so at any point from January 1, 2009 until April 15, 2010.
• Contributions can be withdrawal at any time without paying a penalty. Earnings are treated differently and may incur a penalty if withdrawn prior to retirement age.

It is important to understand how to manage your account properly in order to reap the maximum benefits of your Roth IRA. Many people prefer a Roth IRA as it offers fewer restrictions and penalties due to the fact you are paying income tax on contributions up front instead of when you withdraw your money from the account.

Compare both Roth IRAs and traditional IRAs and the tax benefits associated with each to determine which investment vehicle meets current and future needs of yourself and family.