Named for Senator Roth of Delaware, a Roth IRA is a retirement plan comparable to a 401(k), 403(b) or traditional IRA, but with some fundamental differences. With 401(k)s, 403(b)s and other qualified plans, an individual receives a tax deduction every year that he or she makes a contribution to his or her plan. This immediate tax savings is attractive, but both the contributions and the earnings of these plans will be taxed upon distribution.

With the Roth IRA, however, the contributions are made with dollars after they have been taxed. But once these dollars are in a Roth IRA, they grow tax free. And then later, all distributions (from both contributions and earnings) are received completely free of all income taxes! (As long as the account has been established for five years and the owner is at least age 59 ½.) Roth IRA withdrawals are also tax free if the owner is deceased or disabled or if the distribution will be used for first-time homebuyer expenses.

Today individuals can contribute up to $3,000 and married couples can contribute up to $6,000 to their Roth IRAs. A catch-up provision also allows participants age 50 and above to add an additional $500 per year (with inflation adjustments) to their Roth IRA.

Furthermore, people with adjusted gross incomes less than $100,000 can convert all or a portion of their qualified retirement plans to a Roth IRA. (Generally, any retirement plan that can be rolled over to an IRA can be converted to a Roth IRA. This includes 401(k)s, 403(b)s, SEPs, etc.) While income taxes must be paid on the amount converted, the opportunity for tax-free growth and tax-free distributions could make this a wise choice. (Be sure to consult with a tax advisor to determine the tax consequences of a Roth IRA conversion for individual circumstances.)

To answer that question, consider a simple example of two individuals, Paul and Julia, who are both age 70 and who both have a $150,000 balance in their IRA. Paul has a traditional IRA and as such, he deducted all of his contributions over the years. Certainly these tax deductions have provided him with a valuable tax advantage each time he made a contribution, but when Paul takes the money out of his IRA, his entire $150,000 nest egg is taxable. This means that if he is in a 33% tax bracket, $50,000 of his IRA will be used to pay taxes, and only $100,000 will remain for his own use.

Julia, however, converted her traditional IRA to a Roth IRA years earlier. Again, her current balance is also $150,000. She has met all of the requirements to withdraw her Roth IRA nest egg completely tax free. This means that the dollar value of Julia's Roth IRA is identical to the dollar value of Paul's traditional IRA, but when she withdraws her funds, the after-tax value is 50% greater! The value of Julia's Roth IRA is 50% greater because she can withdraw the entire $150,000 without paying any income taxes. A full 100% of the distributions is available to support Julia's retirement lifestyle.

Of course, it is only fair to consider the taxes Julia would have been required to pay when she converted her traditional IRA into a Roth IRA. Assume she was age 55 when she made the conversion. At that time she had $75,000 in her traditional IRA. If she were in a 33% tax bracket at the time, she would have been required to pay $25,000 in taxes.

She could have taken $25,000 from her IRA to pay the taxes, but that would have left her with only $50,000 remaining in her Roth IRA. The long-term result would likely be that she would have less than $150,000 in her Roth IRA by age 70. In effect, the advantage of the Roth IRA is largely lost if Julia used her IRA money to pay the taxes due at conversion.

But what if Julia had transferred the entire $75,000 from her traditional IRA to her Roth IRA and used other (non-IRA) funds to pay the $25,000 in taxes? This means she would have less in her other savings, but she also would have had $25,000 more in her Roth IRA, earning tax-free interest. And at age 70, Julia would have the full benefit of her $150,000 nest egg as opposed to Paul, who would only benefit from $100,000. (Note: the numbers used in this example are intended solely to illustrate a concept and not to project actual individual benefits.)

Roth IRAs provide one additional advantage that might ultimately prove to be the most important benefit - Roth IRAs are not subject to required minimum distribution rules during the owner's life.

Traditional IRA rules require that the owner start taking required minimum distributions no later than age 70 ½, or pay a 50% tax penalty. Roth IRA participants, however, can choose to never take a withdrawal from their plan for as long as they live. Assuming they have sufficient income from other sources to provide for their retirement needs, they can allow their Roth IRA to continue to grow tax free for as long as they like before passing the entire Roth IRA balance to their heir! The heir could then enjoy an even greater period of tax-free growth by stretching the withdrawals from the inherited Roth IRA over his or her lifetime. (Please visit the "Stretching Your IRAs" link for more information.) This capability provides the potential for tremendous wealth building power.

With a Roth IRA you can enjoy the benefit of a nest egg that grows tax free until it is distributed to you and possibly your heirs - completely tax free! It is a plan that could help make your retirement more secure while allowing you to build a legacy that one day could be passed on to your loved ones.