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Investing 101
Roth IRA
Starting this month we're going to use this section of the newsletter for Financial Education 101. I will cover some basic financial terms and concepts here each month, not only defining the term but hopefully adding something of interest over just the simple definition. This month lets talk about the Roth IRA.
The Roth IRA was established in 1997 and is named after its sponsor, Senator William Roth of Delaware. Roth IRA contributions must come from earnings and they are limited to $5,000 each year ($6,000, if 50 years or older.) Contributions are after-tax and earnings are tax-free once in the Roth. Generally Roths must be held for at least five years and distributions before age 59.5 are penalized. (There are a limited number of exceptions.)
Congress imposed compensation limits on potential Roths participants; in 2011 if a married couple makes more than $179,000 of Modified Adjusted Gross Income (MAGI) neither of them are allowed to add to the Roth. For a single taxpayer the MAGI limit is $122,000--just another example of the marriage penalty, but that's another story.
Roth IRA's are not subject to the Required Minimum Distribution rules and contributions can even be made after 70.5 years of age. Distributions from a Roth do not count as income and as a result may keep your total earnings for Social Security and Medicare below the income thresholds (unlike regular IRA's which may cause Medicare B cost increases and Social Security payments to be taxable.)
Just from those few tidbits of information you begin to get a feel for who can benefit most from a Roth--first, the person is probably modest income and in the lower tax brackets with the anticipation that income will grow in later years. Additionally, one should believe the income tax rates will be higher in the future (pay income tax now at an historically low rate and save it from income later when rates will probably be higher.)
However, that last part does not apply to State taxation--there is a scenario where a person may live and work in a high income tax State (Maryland for example) now but will move to a low or no income State later (Florida for example). In that case the taxpayer would pay current State income tax on the contribution but would not have had to pay State tax on the distribution anyway--so the benefit of tax-free earnings is lost at the State level.
Ironically, by the time someone has the extra money and realizes the advantages of a Roth it is too late to contribute to the Roth because they make too much money. This does not prohibit a parent or grandparent from encouraging a working child to open a Roth. And of course, the best form of encouragement comes in the form of a check to fund the Roth account. This is a good way to start the young person thinking about saving for the future--it also moves money out of your estate--money that might someday trigger State and Federal estate taxes. Remember, the beneficiary must have earned income up to the amount put in to the Roth.
Think about the Roth and try to find ways it might fit into your overall financial plan--there is nothing like tax free earnings to make a person feel warm and fuzzy all over.
Marty
(Material in this newsletter is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources; however no warranty can be made as to its accuracy or completeness. All illustrations shown are hypothetical in nature and do not represent any real investments or tax situations. Actual results may vary. The S&P 500 index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly into an index.) | 
