This post is my contribution to the Financial Literacy Month blogger video project. See more videos shared by Steve at MoneyPlanSOS.
Everyone should know about the Roth IRA. I decided to sit down (in front of a camera…yikes) and answer 10 common questions about them.
Here’s my video, followed by the rough transcript.
1. What is a Roth IRA?
A Roth IRA is an “individual retirement account” or “arrangement” created by the U.S. Government with certain tax-saving features aimed at encouraging you to save more money on your own for your retirement.
2. Is a Roth IRA an investment?
No. A Roth IRA is an account. Not a specific investment. A Roth IRA is simply an account to put your investments, things like stocks, bonds, and cash.
3. How does a Roth IRA work?
A Roth IRA works in the opposit manner as a 401k. After you open a Roth IRA you are allowed to make after-tax contributions into the account and then choose investments. You can withdraw those contributions at any time.
However, since that money is typically invested and those earning are growing tax-free, the money you earn on your contributions generally cannot be withdrawn until you reach 59 and a half. The Roth IRA withdrawal rules can be complicated so be sure you understand them before getting started.
4. Who should open a Roth IRA?
A roth ira is a perfect for anyone just getting started with retirement investing who wants to pay fewer taxes on the money they use in retirement. They are also good for those who have a retirement plan through work (like a 401K) but want to make additional retirement contributions.
The Roth IRA is also good for anyone wanting more control over their retirement investing options.
5. Can you contribute to both a 401k and a Roth IRA?
Yes, in most cases this can be done. In fact, I would encourage you to do both if you have the choice. When I met the eligibility rules I was contributing the max to my 401k and then started contributing to the Roth IRA with my remaining dollars.
6. How do you open a Roth IRA?
There are lots of places to open a Roth IRA. I recommend you check out one of the discount online brokers or mutual fund companies (like Vanguard). The process is very similar to opening a savings account. Provide some basic personal information and fund the account with an initial deposit.
There is typically a “cash” type fund where you can hold your initial deposit while you decide on particular investments.
7. How much can you contribute to a Roth IRA?
The annual contribution limit changes each year, but in 2012 the contribution limit is $5000 per individual, with those 50 or older getting an extra $1000 added to their limit. There are also income limitations that you should review prior to opening an account.
8. What investments do you choose for your Roth IRA?
This is a very personal decision that should be based on your own tolerance for risk and understanding of basic investing concepts like asset allocation and diversification. I typically invest in low-cost target date mutual funds or some type of index mutual fund.
If you choose to open a “self-directed” roth ira you can invest in a number of different things, like real estate, peer lending notes, and even precious metals.
9. Can I rollover an old 401k into a Roth IRA?
Yes. As long as you’ve left the job, you can transfer funds directly from your 401k into a roth ira. Note that you will need to ensure that “direct” transfer takes place.
Also, note that you will need to pay the income taxes on the money you are transferring since the tax treatment of the money in changing.
10. Do you use a Roth IRA?
Yes. Both my wife and I have been using a Roth IRA for our retirement savings since about 2008. We’ve attempted to max out our accounts each year and we’ve kept the investments very simple by mainly investing in low cost target date retirement funds.
I love the security that comes with knowing we’re planning ahead and will be more prepared when we have to retire.