roth ira

Example

“Because she was young and in a low tax bracket, a Roth IRA made more sense than a traditional IRA.”

Memory Tip

ROTH = pay tax NOW, withdraw tax-FREE later. Traditional IRA is the opposite.

Why It Matters

A Roth IRA is important because it allows you to build retirement savings while minimizing your tax burden in the future. By paying taxes now on contributions, you can enjoy decades of tax-free growth and withdrawals, which can result in significantly more money available during retirement compared to other account types.

Common Misconception

Many people incorrectly believe that you cannot withdraw your contributions from a Roth IRA before retirement. In reality, you can withdraw the money you contributed (but not the earnings) at any time without penalties, though the earnings themselves are subject to restrictions until age 59 and a half.

In Practice

Suppose you contribute 7,000 dollars to a Roth IRA at age 25 and invest it in index funds that grow to 280,000 dollars by age 65. You pay taxes on that initial 7,000 dollars in the year you contribute, but then you can withdraw the entire 280,000 dollars tax-free in retirement, avoiding tens of thousands of dollars in taxes you would have paid with a traditional IRA.

Etymology

Named after Senator William Roth, who championed its creation in the Taxpayer Relief Act of 1997.

Common Misspellings

Related Terms

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Other retirement terms you should know

See Also