Individual Retirement Accounts allow you to set aside a portion of your earned income in a tax-advantaged, trustee-based account. There are two basic types of individual retirement accounts; traditional IRAs and Roth IRAs. Both types of accounts provide tax-deferred growth of assets, but there are significant differences between these two types of retirement accounts, particularly with regard to the way contributions and withdrawals are taxed.
You must fund your Roth Individual Retirement Account with after-tax dollars. Unlike a traditional IRA, you cannot deduct your contributions to your Roth IRA when you file your federal income-tax return. You must have earned income from either employment or self-employment before you can contribute to a Roth IRA. You can contribute up to 100 percent of your earned income to your Roth IRA, but no more than $5,000, or $6,000 if you are at least 50 years of age.
All of the assets in your Roth IRA belong to you and you can withdraw them at any time for any reason. You can withdraw amounts equal to the total amount of your contributions at any time without causing a taxable event. Since you have already paid taxes on those funds, the Internal Revenue Service views this type of transaction as a tax-free return of contribution. You do not have to report a withdrawal of your contributions to the IRS.
All earnings in your Roth IRA occur on a tax-deferred basis. No taxes are due on earnings until they are withdrawn from the Roth account. All earnings in your Roth IRA are treated the same for income-tax purposes, regardless of the method by which they are paid into your account. Interest income, dividend income, capital gains and even tax-free interest from municipal bonds are all pooled together and grow tax-deferred. Earnings that remain in your Roth IRA for at least five years become qualified for tax-free withdrawal once you reach age 59 1/2.
All earnings in your Roth IRA belong to you and you may withdraw them at any time for any reason. Once you reach age 59 1/2 you can withdraw qualified earnings, those that have been in your Roth account for at least five years, tax-free. You do not have to report qualified, tax-free withdrawals from your Roth IRA when you file your federal income-tax return. You can withdraw earnings prior to reaching age 59 1/2, but these funds will be taxed as ordinary income and will be subject to a 10 percent tax penalty. Any earnings you withdraw that have not been in your Roth account for at least five years will be subject to ordinary income taxes and a 10 percent tax penalty, regardless of your age.
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