(LifeWire) - For anyone who can't decide whether to save for retirement or for a child's education, decide whether to save for retirement or for a home, or for anyone who simply likes the idea of tax-free income in retirement, the Roth individual retirement account is a great tool.
The rules for a Roth IRA are simple. Rather than getting a tax break on your contributions, as you do with most retirement plans, you pay taxes on all of your contributions to a Roth in the year in which you contribute them. After that, though, no more taxes, for life. Not on the growth of your money. Not on the money you withdraw in retirement. None. Ever.
Of course, the plan has a few restrictions to keep in mind. The growth on Roth investments can't be tapped until age 59 1/2 without incurring a 10% penalty plus taxes in the year in which they are withdrawn. And the account must be open for at least five years before you can tap the growth without owing taxes on it, even if you turn 59 1/2 in the interim.
As of 2009, annual contributions to a Roth IRA are capped at $5,000 per person - $6,000 if you are 50 or over. If your adjusted gross annual income is more than $105,000 as an individual, or $166,000 as a couple, your ability to contribute is curtailed, and it disappears altogether if you make more than $120,000 singly or $176,000 with a spouse.
Withdraw When You Want
So who should be interested? Anyone who believes that their income in retirement may be relatively high, or that tax rates are likely to climb. Also, Roth plans are suited to investors who don't know how or when they will need to use their savings.
Why? Consider the flexibility. Unlike contributions made to a typical retirement plan, such as a regular IRA or a 401(k), the contributions to a Roth IRA can be withdrawn at any time without tax or penalty, because taxes were already paid on the money before it went into the account.
That gives savers - particularly young savers - the best of all possible scenarios when banking money for the unknown future.
Think you'll need money for retirement? Great - leave it in the Roth to grow tax-free until you take it out after age 59 1/2.
But what if you need money to buy your first house five years from now when you are, say, 30? Well, if you have banked $5,000 each year in Roth IRA contributions, you'll be able to withdraw $25,000 for a down payment, penalty-free and tax-free, because you have already paid taxes on that money.
And what if your child turns out to be Harvard material 18 years from now? Well, 18 years of maximum Roth IRA contributions would amount to a $90,000 nest egg - enough to get the little scholars off to a good start while mom and dad continue to benefit from the tax-free growth the nest egg has generated over the years.
A Flexible Setup
The Roth carries other advantages as well. As with any IRA, money in a Roth IRA can be invested in almost anything, including stocks, mutual funds, commodities or real estate.
Roth plans are easy to establish - most banks and brokerage houses can open one for a minimal fee, with annual maintenance fees that shouldn't amount to any more than about $30 a year to pay for record-keeping and reporting.
Money from regular IRAs can also be rolled into Roth IRAs without incurring penalties, but income limits may apply, and taxes must be paid on the money from the regular IRA that's being rolled over, so it's best to consult with a financial adviser before performing such a move.
The advantage over saving in a taxable account, meanwhile, is huge. A 25-year-old putting $5,000 a year into a Roth IRA that earns 8% a year could expect to end up with $1.295 million by age 65. Assuming a 15% federal income tax rate, that's $347,000 more than he or she would amass by investing the same amount in a taxable account, and the difference grows even larger if state taxes are factored in.
