When choosing to invest money in an individual retirement account, many people do not understand the difference between a traditional IRA and a Roth IRA. One main difference is that contributions to a Roth IRA are not tax deductible as they are (subject to income restrictions) with a traditional IRA. In addition, while a traditional IRA taxes earnings upon regular age of distribution, a Roth IRA does not.
There are two types of distributions that Roth IRA investors can take. A qualified distribution occurs once the investor has reached age 59 ½ as long as he or she began contributing to the Roth IRA at least five years prior. An early withdrawal can occur any time, but may be subject to a 10% federal tax penalty, depending on the purpose for which the money will be used.
There are adjusted gross income limits for participation in a Roth IRA and these usually change each year. For 2010, those whose tax filing status is single, married filing separately (and do not reside with the spouse), or head of household may make a full contribution if their modified adjusted gross income is $105,000 or less. Contributions phase out from $105,000 to $120,000, after which point no contribution may be made.
Joint filers may make a full contribution if their modified adjusted gross income is $167,000 or less. Contributions phase out from $167,000 to $177,000. Those with a tax filing status of married filing separately (and living with the spouse) can only contribute to a Roth IRA if their adjusted gross income is $10,000 or less. Roth IRA contribution limits for 2010 are $5,000 for people age 49 and under and $6,000 for age 50 and over. The $6,000 limit includes a $1,000 catch up contribution.
The Roth IRA is a great investment vehicle for middle-income wage earners. Roth IRA contributions and earnings are not taxed upon withdraw except in situations of early distribution. In addition, those who have traditional IRA or 401(k) may be able to convert those investments into a Roth IRA during 2010.