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Roth IRA Rules

Roth IRA rules are fairly easy to understand, and there is every chance that you will be eligible to open a Roth account. Although the rules are easy to understand, it's important to understand the implications of the rules and procedures. It's tempting to rush in to making a decision based in a simplistic approach, but this isn't always the best idea, and in some people's cases, eligibility hasn't necessarily been the same as suitability.

To begin with, let's make sure that we're clear on the basics as far as Roth IRA accounts are concerned, and in particular, how they differ from standard or traditional IRA accounts. You might be forgiven for thinking, based on the overwhelming amount of information available, that there are only two kinds of IRA account. It often seems that you have a straight choice between the standard IRA account, and a Roth account.

In fact, this is misleading since there are eleven types of IRA account. The differences might be relatively negligible, but in terms of eligibility it's important that with a Roth IRA account you are aware of the rules. If you don't follow the rules for a Roth account then you could be looking at severe penalties, including high tax bills - perhaps just at the very time you're thinking of kicking back and enjoying the proceeds from your nest egg.

An IRA or Individual Retirement Account is a way for you to save a capped amount each year tax-free for your retirement. Because of the tax exemption permitted on a Roth IRA, which is different from the tax deferment of a standard IRA, the Internal Revenue Service or IRS has stipulated a number of rules. Clearly, anything that offers a method of avoiding tax is going to be observed very carefully! You don't want to be giving away a single cent of your hard-earned money.

In terms of age, the advantage of a Roth IRA is that anyone can apply to open one. This means that from a relatively young age people can start saving away for their retirement. Equally, it means that even if you are nearing retirement age, you can still open it - it's not too late.

Having said this, there is a limiting factor as far as age is concerned, because if you are nearing retirement, then it may be that you will be nearing the end of the period during which your contributions towards a Roth IRA account will be acceptable.

What does this mean? Very simply, the contributions which you make into your Roth account must come from earnings which are considered as taxable compensation. In other words, the payments towards your Roth account can only come from income sources such as your salary, earnings - including any tips you make, bonuses and any other profits or fees which you raise as a direct result of employment, or of providing a product or service to someone else.

The reason that this rule is in place is to prevent people from taking advantage of a tax free savings and investment facility who are not directly paying tax to the IRS in the first place. Since your income, including bonuses, fees and tips will have already been taxed, your contributions are tax free. However, if you happened to enjoy a large inheritance for example, this money could not be used, because it had not been subject to income tax.

The IRS simply don't think it's far that some people should be able to kick back and enjoy a life free from work, benefitting from inherited money, whilst at the same time making even more money through a Roth IRA investment account. Therefore, the first of the Roth IRA rules to be aware of is that all of your contributions must be paid from money that can be classed as income in one form or another and taxable income at that.

The second rule regarding Roth IRA accounts relates to the amount you earn, and there is both a minimum amount and a maximum. The minimum amount is simply the amount you wish to contribute each year. Fairly obviously, since the IRS only permits contributions to be made from taxable income, if you start making contributions higher than your declared income, they're going to become a bit suspicious!

As far as the upper limits are concerned, these vary each year, in line with inflation. For the current year, 2009, a single individual can open a Roth IRA account if their income is no more than $105,000. For those wishing to open a married couple's joint account the combined income must not exceed $166,000.

However, although this seems a fairly blunt rule, there is a gray edge to it. If your income is slightly above this amount then depending on how much it exceeds these figures you may be eligible to open an account, but will have to follow stricter rules regarding how much you can contribute. This is referred to as a phased out eligibility. For individuals this option is available up to incomes of $120,000, and for joint accounts the upper limit is $176,000.

Although these are the basic Roth IRA rules, it is also important to have a good understanding of the terms of eligibility, and it's not always the income which can be the limiting factor. If you're happy with the rules, then you may wish to look in to whether you meet all of the Roth IRA eligibility requirements.