What is a Roth IRA?

Updated: February 22, 2012 at 11:35 pm PST

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You’ve probably heard the term Roth IRA before, but do you know what it is? Who is Roth and what does he have to do with it? Well, IRA stands for Individual Retirement Arrangement and Senator William Roth was its main sponsor during legislation. The Roth IRA was created as an alternative to the traditional IRA.

A Roth IRA is the most simple form of a retirement account. The biggest difference with a Roth IRA compared to other retirement plans is that rather than getting a tax break on money put into the plan, the tax break comes when the individual withdraws the money in retirement. Like a regular IRA, a Roth IRA is only taxed once. However, with a regular IRA your contributions are tax-deductible, but they are not with a Roth IRA.

So, what is a Roth IRA composed of? The plan will have investments in securities, stocks, bonds, and certificates of deposit. How much risk you take with your investments in a Roth IRA is dependent on what age you start your plan. If you start a Roth IRA at a young age, you’re going to want to tackle more risk so there is the possibility of gaining more money, faster. As people become older, their investing should become more conservative, but if they’re too careful they may never reach their financial goal.

It’s important to understand that a Roth IRA is not a good choice for everybody. If you make more than $105,000 a year, you will only be able to contribute partially. If you make more than $120,000, you can’t contribute at all. Also, there are limits you can contribute each year. For 2012, if you are 49 years of age or younger, you can contribute up to $5,000 of your taxable compensation. If you are 50 years of age and above, the limit increases to $6,000.

Investing in a Roth IRA is an excellent financial decision for young people. If you can continue to invest the maximum amount each year, chances are that you’ll be very well off at age 65 and ready to retire.

Roth IRA