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A Roth IRA is a retirement account funded with money you have already paid tax on. The reward is that, if you follow the rules, the growth and the withdrawals in retirement are free of federal income tax. That makes it a flexible and powerful tool.

The basic idea

With a traditional IRA, you may get a deduction now and pay tax later. With a Roth IRA, you get no deduction now, but qualified withdrawals later are tax-free. Which is better depends mainly on whether your tax rate is likely to be higher now or in retirement. If you expect to be in a higher bracket later, or you want tax-free income in retirement, a Roth often makes sense.

Who can contribute

You need earned income, and your ability to contribute directly is limited as your income rises. The annual contribution limit and the income thresholds are set by the IRS and adjusted over time, so check irs.gov for current figures. Unlike a traditional IRA, there is no age at which you must stop contributing, as long as you have earned income.

Rules for tax-free withdrawals

• Your contributions (not earnings) can generally be withdrawn at any time without tax or penalty.
• To withdraw earnings tax-free, the account must have been open for a minimum number of years and you generally must be at least 59 and a half, or meet another qualifying reason such as disability.
• Earnings withdrawn too early may be taxed and penalized, with certain exceptions.

No required minimum distributions

Roth IRAs have no required withdrawals during the owner's life. That allows money to keep growing tax-free and makes the account a good asset to leave to heirs, who generally receive withdrawals tax-free if the rules are met, though they must usually take the money out within a set period.

Roth conversions

You can convert money from a traditional IRA or an eligible plan into a Roth IRA by paying income tax on the amount converted. Conversions often make the most sense in years when your income is unusually low. Consider whether you can pay the tax from other funds so the full conversion keeps growing.

Smart ways to use a Roth

• Balance your retirement savings between pre-tax and Roth accounts so you can manage your tax bracket in retirement.
• Use it as a backup source of funds, remembering that contributions come out first.
• Pay for retirement health costs or large expenses without raising your taxable income.
• Many employers also offer a Roth option inside their 401(k) plan, which has its own rules.

Mistakes to avoid

Contributing when your income is too high, which can trigger a penalty for an excess contribution; withdrawing earnings early; and forgetting to name beneficiaries.

If you are deciding between a Roth and a traditional account, or thinking about a conversion, contact us and we will model the tax effect.