If you are planning for your retirement, you do need to consider a ROTH IRA in your arsenal. The reasons are numerous, and we will look into several of them in the following paragraphs. Most people know the saying that there is no such thing as a free lunch. Well for the most part that is true; however, a ROTH retirement account does come pretty close to achieving that goal. A ROTH account can lead to years of tax-free funds for both you and possibly your heirs. And the best part is it is never too late to invest in a ROTH account.
When people are younger, they tend to be earning less money than they will later in their career. While it is true that a Traditional IRA does offer immediate tax deductions on your current income taxes, these may be leaving you a great deal of money on the table later in life. The nice thing about a ROTH IRA is provided you are not a high-income earner you are eligible to open an account. One of the main differences between the two types of IRA’s is you pay taxes on the funds you put in the IRA now in the ROTH account. Then provided you are 59 ½ and have had the account for five years all the earnings are withdrawn tax-free.
The limits on IRA’s are the same for Traditional and ROTH being $5,500 for 2015 for those under age 50 and $6,500 for those over 50. I recommend IRA’s in addition to employer 401(k) plan when it comes to retirement investing. I also always recommend you at least contribute up to the point where your company stops its matching program. There is no reason to leave free money on the table when it comes to your retirement. So if you can contribute the maximum to your IRA as well as your 401(k), in 2015, the annual contribution is $18,000 unless you are over the age of 50 in which case it is $24,000.
While you are younger and do not have a large amount of disposable income it may seem out of the ordinary but having compound interest work in your favor is an advantage you want to maximize. Also, it is a good idea and practice to have retirement accounts in different tax-advantaged forms. I recommend taxable, tax-deferred and tax-free accounts to everyone as they all will serve a valuable purpose in your retirement years. If you think your tax bracket will be higher when you are retired, it makes sense to contribute as much as you can to a ROTH account now and enjoy the tax-free advantages later. If you think your tax bracket will be lower, then a Traditional account will make more sense. I do not see taxes getting much lower in the future, so I am a proponent of any ROTH account.
If you are single and earn more than $131,000 or married earning more than $193,000, you will not be eligible for a ROTH IRA. But do not worry there are legal ways around this issue. The most common way is to contribute to a Traditional nondeductible account then perform a ROTH conversion. Anyone can convert a taxable account into a ROTH provided they can pay the taxes on the amount converted. If you are lucky, you may be able to time your conversions to minimize taxes such as market downturns. Also, if your employer offers a ROTH 401(k), there are no income limitations on those.
There is some difference between a ROTH IRA and a ROTH 401(k) with the main being a 401(k) does require a minimum distribution. In that regard, they are similar to Traditional and IRA and 401(k) and require these withdrawals at age 70 ½. And it is good to note that a converted ROTH has a period when the conversion may be reversed. A converted 401(k) has no such reversal so if you do convert a 401(k) into a ROTH account make sure that is indeed what you wish to do as they is no way to reverse this decision.
And the tax advantages of having ROTH accounts are numerous and generous as well. If you have ROTH accounts in addition to Traditional ones a tax-free withdrawal may keep you flush with cash but out of the next higher tax bracket. And if you retire at a younger age and can defer Social Security by living on your retirement accounts you can get an extra 8% a year in those payments. This means using your retirement accounts to live until you are in desperate need of Social Security. Now I am not saying not to collect your benefits but if possible it is wise to defer them as long as you can or until your full retirement age. This is one reason I do recommend all three types of investment accounts, so it is possible to draw funds from different pools of funding.
As an extra reason to consider a ROTH IRA, you can make withdrawal your principal at any time without penalty. Also, you are allowed to use $10,000 towards the purchase of your first home. And if you have kids you may withdrawal funds including earnings and just pay the taxes with no early withdrawal penalty imposed.
And if you want to look out for your children a ROTH IRA is truly a God sent retirement tool. Provided the children have earned income they are eligible for a ROTH IRA. If you are a small business owner, you can pay your children or even grandchildren and then contribute the amount that they have earned or the annual contribution limit. The earning power of an IRA over 40 plus years is amazing. If you do not, believe me, try to use Excel and do the future value function and see for yourself.
A ROTH account is a wonderful thing if used in conjunction with other types of accounts. If you have any questions about ROTH accounts or how to best utilize them, feel free to contact me directly.
