The Roth IRA

If you aren't contributing to a Roth IRA already, maybe you should be, as it offers potentially massive tax breaks. There are some important issues to consider first, though.

Like other IRAs, the Roth allows you to accumulate funds for retirement and to enjoy some tax advantages at the same time. While traditional IRAs are taxdeferred, Roth IRAs are designed to be tax-exempt. Traditional IRAs permit you to contribute pre-tax dollars; Roth IRAs accept only already-taxed dollars.

Let's say you're 40 and you invest $5,000 of your post-tax income into a Roth IRA each year, starting today. You earn a 10 percent annual return for the next 25 years until you retire at 65. By then, your contributions would have grown to about $540,000. With a Roth, that's your takehome pay, tax-free.

If those investments had been made into a regular IRA, you'd pay taxes on any withdrawals, netting just $460,000 or so, assuming a 15 percent tax bracket during retirement, or merely $405,000 if you're in a 25 percent bracket. So far, this makes a great case for the Roth. But remember that if the $5,000 had gone directly into a traditional IRA, you would have reaped about $1,250 in tax savings each year at a 25 percent tax rate (more, with a higher tax rate). If that savings was also invested, the total difference between the Roth and the regular IRA would become slimmer. Still, the Roth is a very compelling proposition to most investors.

You may be able to roll over, or convert, your traditional IRA into a Roth by paying taxes on it, counting the entire value of the account as income. You can also roll over a 401(k) account into an IRA when you change jobs.

There are more benefits and limitations to consider before you decide whether the Roth is for you. Get details at www.irs.gov, www.fool.com/ira, or from a tax professional. For clear and concise retirement advice, along with stock and fund recommendations, take advantage of a free trial of our Rule Your Retirement newsletter at www.ruleyourretirement.com.