roth iraThe Roth IRA is a special type of retirement investment account that provides unique tax advantages to the individual investor. The advantage of a Roth IRA is that the withdrawals of both contributions and earnings, after meeting certain requirements, are tax-free. This is unlike a conventional IRA where the earnings are taxable upon withdrawal.

There are several eligibility rules that first must be met to invest in a Roth IRA. Your income during the year must be equal to or greater than the amount you are planning to contribute to the IRA. The 2012 contribution limit for individuals under age 50 is $5000 ($6000 if over age 50). Income limits have been set as well for the Roth IRA. The single filer contribution limit starts phasing out once an individual’s income reaches $110,000, while the limit for joint filers begins phasing out at $173,000. Finally, as with a regular IRA, contributions must be made for the previous year by the tax filing deadline of the current year.

A Roth IRA differs from a conventional IRA in several ways. The most significant is how withdrawals are treated. Contributions for a Roth IRA are not tax deductible, while they are for a conventional one. Distributions from a conventional IRA are treated as taxable income while they are tax free from a Roth IRA, assuming certain conditions are satisfied. In a conventional IRA, contributions must stop at age 70 ½ and minimum annual distributions must be taken at this time as well. The owner of a Roth IRA has no minimum distribution age requirement and can continue to contribute as long as all the eligibility requirements have been met.

In a Roth IRA, because contributions come from taxed income, withdrawals of contributions may be taken at any time, without penalty. As long as the withdrawal is taken a minimum of five years after the initial contribution, earnings on contributions can be withdrawn without taxes or penalties at age 59 ½. Under normal circumstances, on an early withdrawal, earnings will be subject to the individual’s marginal tax rate as well as an additional 10% penalty. There are several scenarios where the penalty does not apply such as a down payment for a first-time homebuyer or medical expenses once a threshold is met. It is best to consult with a tax advisor for questions on early withdrawals due to the frequently changing rules.