Roth IRA

A Roth IRA, created by US law in 1997 and named after Senator William Roth, reverses the tax treatment of a traditional IRA. Contributions come from income that has already been taxed and are not deductible, but investment growth is tax-free, and withdrawals are tax-free once they are “qualified”, which generally means the owner is at least 59½ and the first Roth contribution was made at least five years earlier. Direct contributions are capped by an annual limit set by the IRS and are phased out for people with incomes above thresholds that are adjusted each year.

The choice between Roth and traditional comes down largely to whether you expect your tax rate to be higher or lower when you withdraw than when you contribute: paying tax now makes more sense if you expect a higher rate later. Roth IRAs have further advantages: the original owner is not required to take minimum withdrawals, and contributions, though not earnings, can be taken out at any time without tax or penalty. The main risks are that tax law can change and that income limits stop higher earners contributing directly. For UK readers, the tax treatment resembles an ISA, though a Roth IRA is designed for retirement.