For many people, a Roth IRA is an excellent vehicle for saving for retirement. You can contribute any amount you wish to your Roth account up to the allowable limits based on your age and income level, and the earnings accumulate on a tax-free basis. A prominent feature of the Roth is that you can begin to take tax-free distributions once you reach age 59 1/2, which eases your tax burden during your retirement. However, while a Roth offers a number of key benefits, it also poses a few potential problems.
No Immediate Tax Deduction
If you are looking for an investment vehicle that will lighten your tax burden for the current year, a Roth IRA isn't it. Unlike a traditional IRA where some or all of your contribution may be tax deductible, the Roth is funded with after-tax dollars, meaning taxes have already been withheld. You will have to wait until you begin to withdraw the money in the form of qualified distributions at retirement to reap the true tax benefits of the Roth.
If you're a high earner, you may not be able to contribute as much to your Roth as you'd like. If you are married and filing jointly, for instance, the amount you are permitted to contribute begins to get phased out if your adjusted gross income (AGI) reaches $173,000. Additionally, you can't contribute at all once your AGI reaches $183,000 as of 2012. If you're single, the phaseout begins at $110,000 and allowable contributions end at $125,000.
While contributions can be taken out of a Roth IRA at any time without further taxation or penalties, if you take earnings out of your Roth prior to reaching age 59 1/2 you will incur a 10 percent early penalty. The Roth IRA must also be in force for at least five years before you can make penalty-free earnings withdrawals. There are certain exceptions to the rule, such as when you use the money to make a down payment on your first home.
The amount you can contribute to a Roth in a given year is $5,000 (unless your income level mandates a phaseout or makes you completely ineligible) if you're under age 50, and $6,000 if you are 50 or older. In contrast, a 401(k) allows you to contribute up to $17,000 per year if you are under 50, and $22,500 if you are 50 or over as of 2012. If you have no other source of retirement funding, a Roth IRA may not be enough to provide for a comfortable retirement, particularly if you are getting a late start on saving.