Vital Roth IRA Rules You Should Know

Prior to setting up this retirement account, individuals need to know Roth IRA rules. As with all types of retirement accounts, unless these rules are followed, you could face significant taxes and fines on the funds you have put away. The Internal Revenue Service, or IRS, updates these rules from year to year. You can find more information about changes at the IRS website, or by contacting your financial advisor.

What Are The Important Roth IRA Rules?

In many ways, the Roth IRA is similar to the Traditional IRA. One of these rules is that the IRA needs set up in a financial institution that meets the requirements of the IRS. You cannot manage your own IRA account in your safe deposit box, in other words. You can use a local bank, credit union or another type of financial institution or financial advisor to manage these funds. In order for the account to receive the benefits of Roth IRA under federal law, it must be designated specifically as this type of account prior to doing so.

One of the most important rules is in regards to Roth IRA withdrawals. The funds contributed to a Roth IRA are meant for retirement years. Individuals are unable to withdrawal the funds for use earlier without facing heavy taxes and fines on these funds. An early Roth IRA withdrawal is never recommended, unless you meet the qualifications for a qualified distribution. Qualified distributions, which is the term used to describe allowable distributions from the retirement account occur when:

• The funds are taken from the account on or after the person reaches age 59 ½.

• The funds are removed from the account after the account holder has died, at which time the funds are sent to the beneficiary listed by the account holder on the IRA documents.

• The funds are used to provide for the account holder’s disability needs, which must be approved as a disability.

It is only when you meet these qualifications that you can withdraw funds from a Roth IRA without facing tax penalties. Unlike a Traditional IRA, the funds withdrawn from this IRA are tax free. Tax free withdrawals occur because the funds invested in the account are pre-taxed at the time of investment. This type of retirement account is best for those who are likely to have a lower income tax bracket at the time of investment than they will have at the time of withdrawal of the funds.

Contributions

Another type of Roth IRA rule has to do with contributions. The investor through a financial institution makes contributions. You can make contributions from the time you open the account until you enter into retirement and begin to take qualified distributions from the account. However, unlike a Traditional IRA, it is possible to make contributions through retirement as well. You can do this even after you reach age 70 ½. At that age, you must begin to make mandatory withdrawals from your Roth IRA, though.

The funds can remain in your retirement account for as long as you are alive. Some people do not start taking withdrawals prior to their death, in which case the funds are directed to the beneficiary listed in the documents. Because of the ability to continuously invest in this type of account, many people use the Roth IRA as a part of their estate plan. It allows them to leave funds behind for specific people after they die. If you wish to use the Roth IRA for this benefit, discuss the process with a financial planner before getting started.

Additional Important Roth IRA Rules

As you take into consideration your options for opening a Roth IRA, it is important to consider a few additional rules for using these accounts. As always, it is a good idea to work with a financial advisor when making decisions about your account.

• Any type of contribution that you make to this plan must be done in cash payments. This is usually done in the form of a withdrawal from your paycheck that is placed directly into your account. Keep in mind that rollover contributions do not follow this rule.

• You cannot use the funds in your Roth IRA account to purchase any type of life insurance policy. When the funds are withdrawn as an early withdraw, you must tell the financial institution why you are removing these funds from the account specifically.

• You cannot forfeit the money under any circumstance. When the account is set up as a designated retirement account, the financial institution must agree to the fact that the account gives you a non-forfeitable right to those funds. No one can take the funds from you for any reason. A good example of this is bankruptcy. The funds in your Roth IRA are protected from creditors during the bankruptcy process.

• You have very limited ways to combine your property. You cannot combine most types of property with your Roth IRA account. For example, you cannot place untaxed earnings in the account alongside those that have already been taxed. The only way that the property can be combined is in a common trust fund or in a common type of investment fund.

• You cannot invest more than the allowable amount of contributions for the year. The amount you can invest does change from year to year.

There are a few additional notes to keep in mind. You can open Roth IRA accounts on your own. You do not have to use an employer to open this type of account. In addition, your employer can make contributions to your Roth IRA account if the employer choices to do so. It is possible, in some cases, to use a Roth IRA conversion, which means that you can move fund from a traditional IRA or other type of retirement account into your Roth IRA account but the funds will be taxed as necessary so that the funds can grow tax free throughout your life and through your retirement years.