Before getting into the nitty gritty about which company has the best Roth IRA, or what investment options should I choose from my Roth IRA, one should have a a clear understanding of what a Roth IRA actually is.  Heck, even the term IRA is confusing to most.  The acronym IRA stands for Individual Retirement Agreement, not Individual Retirement Account as most think.  So why agreement and not account?  Well all IRAs will have an account associated with them, but the agreement part stems from the fact that this entire investment vehicle is borne from an agreement with the government over how taxes affect the way the money grows and what happens upon withdrawal of the money in terms of taxes and possible penalties.  An example of this would be that in a standard IRA the money is put in pre tax (i.e. before the federal, state and local governments take taxes out of your wages) and is allowed to grow tax free until retirement.  At that point, withdrawals will be taxes like ordinary income.

But we don’t care about standard IRAs in this conversation, so let’s dissect what a Roth IRA is and what the federal goverment has baked into their agreement for Roth IRAs.  First, a Roth IRA comes from after tax money.  This is one of the key differences to it as opposed to almost all other retirement vehicles.  All the money you contribute to your Roth IRA comes from money that is earned and then taxed by the state, federal and local goverments first.  This obviously makes it quite a drain on how much money you have available to place into the account.  So why is this a good deal then?  Well the way it grows is the same manner as almost every retirement vehicle.  While it is in the account no taxes are due upon any gains, dividends, earnings, etcetera.  The beauty of the Roth IRA comes when it is time to withdraw your money.  At this point you can withdraw any and all money tax free.  So you paid the taxes going in, now you are only taxed once on this money and that then means that the entire sum of money in the account is yours to withdraw in retirement in full.

A few other key things that are germane to what a Roth individual retirement agreement.

  1. You can withdraw any of your contribution money at any time without penalty.  So whatever you place into the account is available for any reason at any time.  Note that this doesn’t include any earnings you have made in the interim, but if you put in $5,000 per year 4 years straight you would be able to withdraw the entire $20,000 whenever you please without penalty or any taxes.
  2. You can begin taking withdrawals tax free starting at age 59.5.  Up until that point you would incur a penalty on the withdraws on the earnings of the account.
  3. If you do want to withdraw the entire amount and you are under 59.5 years old you still can, you just are subject to a 10% penalty on the earnings as well as taxes on those same earnings.  So in the above example if you had contributed the $20,000, over those 4 years it had grown to $24,000, you wanted to withdraw the entire amount, and you are less than 59.5 years old you would be subject to the following:
    1. $20,000 comes out tax free and clear
    2. $4,000 would be charged a 10% early withdrawal penalty so you would pay in $400
    3. The $4,000 would be subject to taxes.  So if your marginal tax rate is 25% that would entail another $1,000 in taxes on that money.
    4. You would walk away with $22,600

So there you have it, a quick synopsis of what is a Roth IRA.  For an in depth look at all the specifics of the Roth IRA go to the IRS website.