RETIREMENT SAVINGS TERMS
What is a
SMALL
A Roth IRA is one of the most popular ways for individuals to save for retirement, and it offers some big tax advantages, including the ability to withdraw your money tax-free in retirement. In fact, many experts consider the Roth IRA the best retirement option available.
Here’s how the Roth IRA works, what it offers and how it compares to a traditional IRA.
If you already know you want a Roth IRA, it’s tremendously easy to open one and get started.
The Roth IRA offers big tax advantages
What are the other rules?
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SMALL CAP?
Like its cousin the traditional IRA, a Roth IRA offers individuals an opportunity to save for retirement on a tax-advantaged basis. You can deposit after-tax money into the account, grow that money and then take it out at retirement (age 59 1/2 or older) and never pay taxes on it. The whole “tax-free forever” part? That’s what turns heads, but the Roth IRA offers other perks.
Jeff bought a vacation home for $100,000 and used it as a rental property for five years before selling it for $150,000, giving him a capital gain of $50,000.
Since he owned the property for more than one year, he calculated his long-term capital gain based on his tax bracket.
Since his annual income placed him in the 15 percent tax bracket ($37,651 to $91,150 for a single person in 2016), he didn’t have to pay any taxes on the profit.
EBITDA doesn’t need to be measured by the Securities and Exchange Commission’s accounting standards, the Generally Accepted Accounting Principles (GAAP), so it is not a required line item on a company’s financial statement. EBITDA has become much more common in recent years, although many firms list an adjusted EBITDA figure.
You can withdraw any contributions and earnings tax-free at retirement, with only one stipulation:
Before the proliferation of
inexpensive computer
technology, it had been very
difficult to create and price
complicated derivative contracts, but this problem was more or less solved by the 1990s, thanks also to the Black-Scholes equation. Mortgage-backed securities became very common investment products. Instead of using derivatives to effectively balance risk, institutional traders began buying them up as ways to create leverage and take on much more risk. When the U.S. housing market began to crumble in 2006 and 2007, MBS investments spread throughout the banking system began to rapidly lose value, precipitating the crisis.
The measure can be calculated by taking a company’s net income and adding back interest expense, taxes, depreciation, and amortization. Alternatively, it can be calculated by taking a company’s operating profit — EBIT, or earnings before interest and taxes — and adding depreciation and amortization.
Susan opens a credit card with a $1,000 credit limit and an interest rate of 14.99.
She makes a purchase of $200.
Susan understands she will pay interest on the balance until she pays it off, but she decides to carry a revolving balance.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
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Its tax-free nature makes
the Roth IRA especially
attractive if the account is
likely to be passed down,
since it can save the
inheritors significant taxes.
Plus, you’re never too old to
invest in a Roth IRA, so you can stash money there your whole life, as long as you qualify (see below).
Roth
IRA?
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
The Roth IRA is flexible. You can withdraw contributions any time tax-free (since you’ve already paid taxes on them). If you take out earnings early, though, you can be hit with taxes on the gains, though some uses, such as for qualified educational expenses, can help you avoid taxes. In addition to taxes on your gains, early withdrawal may lead to a 10 percent bonus penalty.
A SMALL CAP COMPANY
five years must have elapsed since your first contribution to a Roth IRA,
and the clock starts on January 1 of the year you made it. The five-year rule is important to remember, and it means that you need to open a Roth IRA earlier and plan a bit ahead.
$6,000
MAXIMUM ANNUAL CONTRIBUTION
IF YOU'RE OVER 50
+ $1,000
In 2021, you’re allowed to contribute up to $6,000 annually to your Roth IRA. If you’re over 50 years of age, you can make an additional catch-up contribution of $1,000 each year.
The Roth IRA is also a great rollover option if you have a Roth 401(k) as a retirement account. You can roll the money from the employer-sponsored account, which has a required minimum distribution in retirement, to the Roth IRA, where there are no required distributions.
Who can open a Roth IRA?
In general, anyone with earned income (here’s what counts) in a given year can contribute to a Roth IRA. You can add up to the lesser of the maximum annual contribution or your earnings.
There is an exception, however, and it’s called the spousal IRA. If your spouse earns money, you and your spouse each are able to contribute up to the maximum contribution or your total annual income, whichever is less.
In addition, the Roth IRA places income limits on who can contribute directly, though you have ways around that. The limits for 2021 include:
Individual Filer: $125,000
If you’re an individual filer you can contribute the maximum amount if your modified adjusted gross income is under $125,000. The limit is reduced and phases out up to income of $140,000.
If you’re married filing jointly, you can contribute the maximum amount if your modified adjusted gross income stays below $198,000. The limit is reduced and phases out up to income of $208,000.
Married filing jointly: $198,000
If you make above those amounts, you can still open a Roth IRA, but the route is a bit more roundabout using what’s called a backdoor Roth IRA. The short of it is that you can open a traditional IRA and then convert the account to a Roth, but here are the full details.
The other main kind of individual retirement account is the traditional IRA, and that can be a valuable savings vehicle for
retirement, too. In contrast
to the Roth IRA, the
traditional IRA allows you
to make contributions on
a pre-tax basis, meaning
you get a tax break this year
on what you put in. At retirement
(age 59 ½ or older), you’ll pay regular
taxes on any withdrawals.
Roth IRA vs. traditional IRA
The traditional IRA does have income limits, so that if you make too much you won’t be able to use pre-tax money to do so. But you can convert the account to a Roth IRA and get a tax advantage that way. The traditional IRA has required minimum distributions in retirement.
Bottom Line
Because of its ability to shield taxes on earnings forever, the Roth IRA is one of the most popular retirement savings options. But don’t overlook the Roth IRA’s other valuable features, including no required minimum distributions and attractive estate planning benefits.
