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What is a Roth IRA?

Before I start with my usual craziness, I need you to identify yourself as one of two kinds of people: those who know about Roth IRAs, and those who don’t. If you already know about Roth IRAs and maybe even have one yourself, think about how awesome it is. Now think about how awesome it would be if all your friends knew about it too. Give some extra thought to the young people you know who can take advantage of about 40+ years of compound interest in a Roth. Now be a good friend and send this video to them! This video is for them! You can use the tweet button to your right, or better yet, just send them an email with the link and a note telling them how much you care.

Now for the craziness. I need to tell you I’m a nerd. I talk about nerdy things like video games and the origins of idioms (did you know “How come…” is an abbreviation of “How did it come to be that…”?) and personal finance.

Sometimes I will be talking about investing and I’ll casually mention my Roth IRA, and sometimes the person I’m talking to gives me the, “Who is this Roth dude and why are you giving him money?” look. I want to fix that.

This video does a great job of explaining how investing works outside of a tax deferred account, and then explains the benefits of a Traditional IRA and Roth IRA. It will also make you laugh so hard you’ll have milk come out of your nose. Even if you aren’t drinking any milk. It’s weird.

There are a bunch of great things about a Roth IRA, and I’m gonna give you the most important stuff right now.

First, a Roth IRA is a retirement account. It can have stocks, bonds, mutual funds, CDs, savings bonds, or just about anything else you might want. It is very flexible. Now for the other cool stuff:

  • You pay taxes up front (in the form of income tax) so your money grows without capital gains taxes and also isn’t taxed when you withdraw from the account (if you follow the rules)
  • You can remove your contributions at any time. That means if you put $1,000 in the Roth IRA, you can take $1,000 out at any time for any reason (unless you’ve lost money in your investments, in which case you can only take out what you haven’t lost)
  • Your capital gains (interest earned) are never taxed !
  • You can remove interest earned without taxes or penalties if they are used for qualified distributions, such as buying your first home or paying for higher education, but only after the account has been open for 5 years.
  • The maximum annual contribution is $5,000 in 2010, unless you are older than 50 in which case your limit is $6,000

If you want the full (boring but important) details on a Roth IRA, check out the Motley Fool. If you want to sign up for a Roth IRA right now, I suggest either Betterment or Personal Capital. Betterment and Personal Capital are both part of an industry shift towards robo investing. Personal Capital is a bit better in that you get access to a real person if you sign up with them, but both companies have attracted a ton of capital, so they are doing something right. ๐Ÿ™‚

It doesn’t take a genius to know the importance of saving money early; all it takes is a quick look at this video. So if you have friends who aren’t saving money and don’t know about the awesome benefits of a Roth IRA, send them this video and save their financial lives.

If you already have a Roth IRA, where do you have it and what do you invest in? Let’s find the best places to maintain your Roth and the best investments to put inside one. Leave me some comment love below!

*Post featured at Carnival of Personal Finance

10 thoughts on “What is a Roth IRA?”

    1. Thanks CityFlips. I hope people start to get it. It can be complicated, but not when you bring in Jean-Luc Picard

  1. Kevin,

    Very nice insight and tip on Roth IRA.. I did not know a thing about it but now a pretty good understanding of it after watching the video. Thanks for sharing this! I’ll be sure to pass it around.

    1. That would be awesome! I’m definitely including your post in my roundup tomorrow. You are definitely saying what everyone is thinking there.

  2. Excellent video Kevin. I can’t imagine the amount of work that went into it.

    There was just one little slight of hand though. Perhaps you can cover it in a future episode.

    If you’re using a traditional IRA, you earn $6,600 and $5,000 goes to the Traditional IRA. The other $1,600 would be taxed leaving $1,200 that could be invested. So you would have $5,000 pre-tax growing in the traditional IRA and $1,200 post-tax growing in a non-IRA account.

    The results of THAT is what should be compared to a ROTH IRA.

    1. I completely agree that would be the best way to get an accurate comparison of using both types of accounts. However, this video wasn’t trying to compare potential returns; it was only trying to explain the difference between the two.

      I’m glad you’re on top of the small nuances and keeping me honest though. ๐Ÿ™‚

      1. I agree that it may have made the video too complicated to show that additional detail, but I find it annoying when slight-of-hand is used. You have to admit that that $1,200 invested each year would make a great emergency fund and with growth would pay a lot of taxes when the traditional ROTH is withdrawn.

        That said, even though I’m 50, I’m still investing in ROTHs and I even did some conversion (from a previous Traditional IRA) to pay the taxes from my current income. Seeing that money growing tax-free is just too much fun! Of course if the government enacts a VAT type tax later, Uncle Sam will have the last laugh on us because we’ll have to pay the VAT tax when we spend our “tax-free” ROTH monies.

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