Roth IRAs: Everything You Wanted To Know

With tax season crouching surreptitiously on the horizon, suggestions for appropriate tax moves pop up frequently.

Many of the more common recommendations revolve around Individual Retirement Accounts (IRAs). Suggestions range from opening an account to converting from Traditional to Roth IRAs and topping off annual contributions to IRAs, effectively suggesting that no matter the current position or age of an IRA, these types of savings vehicles should be looked at closely as April 15 approaches.

Despite the publicity and seemingly straightforward advice, the specifics concerning IRA types are often glossed over. There are essentially two options for IRAs: Traditional IRAs and Roth IRAs.

Related Link: 9 IRA FAQs: Invest In Yourself, Educate Yourself

Due to the proclivity of recommendations for converting to Roth accounts, a greater understanding of how Roths function is beneficial for anyone considering this route or deciding to open her first IRA.

Basic Breakdown

Eligibility: Roth IRAs are available to anyone with earned income below a specific amount. For 2014, the (MAGI) income cap for single filers is $114,000, married filing jointly is $181,000 and married filing separately, $10,000. Filers exceeding this income limit are ineligible for Roth IRAs.

In other words, whether the individual's taxable income is $500 or $50,000, a Roth IRA could be a financially savvy savings vehicle.

Contributions: Contributions can be made any year in which taxable income is earned. This is one stipulation regarding Roth IRAs: if no income is earned for a year, no contributions can be made. The upside to this is that Roth IRAs allow for stop-and-go contributing and the account remains active regardless of annual contributions.

For 2014, the maximum amount allowable for full annual contributions is $5,500 for singles under 50. A few things to keep in mind about Roth contributions, though:

• Partial contributions can be made for individuals who are slightly above income cap. For 2014, individuals with a MAGI between $114,000 and $128,999 are still allowed to make minimal contributions. Those who are married filing jointly with a MAGI between $181,000-$190,999 follow the same regulations, as do married filing separately individuals making between $1 and $9,999.
• Contributions cannot exceed the amount earned. So, while someone earning a taxable income of $500 can contribute, the amount cannot exceed $500.
• Those above 50 can contribute a “catch up” amount of $1,000 annually, bringing the total contribution limit to $6,500.
• The year is from tax season to tax season; so, 2014 contributions can be made up until April 15, 2015.

Taxation: Roth IRAs, unlike Traditional IRAs are taxed on the front. As the contributions are not tax-deductible, the amount contributed is factored into annual income amounts; therefore, taxes are paid on contribution amounts at the time when taxes are completed.

One benefit of paying taxes upfront is that the growth within the account is typically not taxed. One exception to this would be if the account holder were to withdraw for an unqualified distribution. In most instances, however, taxes are not due for Roth IRA accounts or withdrawals.

Related Link: Roth IRAs For Kids? Take A Closer Look

Withdrawal Regulations: Withdrawals can be made from the account at any point in the account and the account holder's lifetime. Where Traditional IRAs implement a regulation requiring the account holder to withdraw a minimum amount annually after a certain age, this is not the case with Roth IRAs. In theory, the account can go untouched for the entirety of the original account holder's life.

Beneficiaries: Roth IRAs can be inherited. Do not risk the loss of the account amount by not ensuring its longevity beyond the individual's lifetime.

As Forbes' Rob Russell explained the frustrations of incomplete beneficiary designations, “It's typically due to one of two mistakes. First, there are no beneficiaries listed beyond the primary beneficiary…with everything in life you must have a contingency plan, so make certain you have a contingent beneficiary listed on your Roth.”

“Second, if there are beneficiaries listed they are vague…there's a big difference between ‘named beneficiaries' and ‘designated beneficiaries', be specific. List their name, DOB, social security number and address to avoid confusion and problems upon inheriting the Roth.”