Roth IRA

A Roth IRA is an individual retirement account (IRA) in the United States. A Roth IRA may invest in a variety of options such as stocks or mutual funds. As with all IRAs, there are specific elegibility and filing status requirements mandated by the U.S. Internal Revenue Service. A Roth IRA's main advantage is its tax structure. Contributions are made post-tax; earnings and withdrawals are federal income tax free. In contrast, contributions to a traditional IRA are made pre-tax and earnings are tax free, but withdrawals are subject to tax. Another advantage of the Roth IRA is that there are fewer restrictions on withdrawals than with a traditional IRA.

Disadvantages

The main disadvantage of a Roth IRA, in comparison to a traditional IRA, is that the contributions are in general not tax deductable. With the assumption that one is in a 30% tax bracket and then contributes $1000 to a traditional IRA, the individual would pay $300 less in taxes, and hence the investment would only cost the investor $700. This advantage does not exist for the Roth IRA. It should be noted, that the money in a traditional IRA is taxed once it is withdrawn at retirement. If one is in a lower tax bracket at retirement, then a traditional IRA would offer a tax advantage.

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There are also heavy penalties for early withdrawals. An early withdrawal will result in a 10% penalty, and the money can be taxed as regular income, instead of the tax-free status that the money would enjoy in retirement.

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