Roth IRA vs. Roth Contributory IRA

By Markets Fool.com

The Roth IRA is an important retirement savings tool for those looking to put away money for the future. The sooner you begin setting money aside for retirement, the longer you'll have to accumulate wealth for when you need it the most.

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Traditional IRA
With a traditional IRA, you contribute money on a tax-free basis, provided that you meet certain IRS criteria. For 2016, the contribution limit for a traditional IRA is $5,500 for those under 50 and $6,500 for those aged 50 and older. You're free to start taking withdrawals from your IRA once you reach age 59-1/2, at which point you'll pay taxes on them, and if you access those funds before you hit 59-1/2, you'll be liable for a 10% penalty on whatever amount you withdraw.

Roth IRA
A Roth IRA works similarly to a traditional IRA, but the main difference is that your contributions are not made on a tax-free basis. Rather, you'll pay taxes up front on what you put in, but when you start taking withdrawals in retirement, those distributions will be tax-free. The contribution limits for a Roth IRA are the same as those of a traditional IRA, but if you earn too much, you may be deemed ineligible for a Roth IRA. For 2016, single tax filers earning $132,000 or more are ineligible for a Roth IRA; those who are married, file jointly, and earn $194,000 or more are ineligible as well.

As with a traditional IRA, if you hold a Roth, you can start taking distributions once you reach age 59-1/2, provided that the money has been in your IRA for at least five years. If you make withdrawals prior to that age, you'll pay a 10% penalty on your earnings, but not on your original contributions. It's possible to convert a traditional IRA to a Roth IRA, but in order to take tax-free distributions, you'll need to wait five years from the conversion date to withdraw funds.

Roth contributory IRA
The difference between a Roth IRA and a Roth contributory IRA is based on how the account is funded. A Roth IRA can be funded by converting a traditional IRA to a Roth or by opening up an account and making contributions directly. If your Roth IRA is funded by your direct, fresh contributions, then it is considered a contributory IRA.

Roth IRA withdrawals
If your Roth IRA consists solely of money you contributed directly, then you can take that money out early and avoid penalties and taxes. However, if you withdraw money prior to age 59-1/2, and before that money has been in your account for five years, then you'll be subject to taxes and penalties on the earnings portion. Let's say that over the course of a five-year period, you've contributed $2,000 a year to your Roth IRA for a total of $10,000, and your current balance is $14,000 because your contributions have generated an investment return. Now let's assume you're not yet 59-1/2 but want to withdraw some money nonetheless. If you withdraw just $10,000, you won't be taxed or penalized. If you withdraw the full $14,000, then you'll be subject to taxes and penalties on the $4,000 you didn't contribute directly.

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