I am a firm believer that in today’s political environment taxes will go nowhere but up even for those of us in our retirement years. If you can I suggest using ROTH IRA’s and 401(k)’s to your benefit so your may enjoy the fruits of your labor tax free when you do retire. Now ROTH IRA’s do have income limitations so they are not for everyone especially high income earners. But there are no restrictions on a ROTH 401(k) provided your employer offer that option to you. Basically both work like this, you pay taxes on the money now in your current tax year and the money will grow until you retire or reach age 59 ½ and then all of the proceeds that you contributed are tax free. Now if you have a ROTH 401(k) and your employer gives you a match that portion of your 401(k) will be considered Traditional and taxes will have to be paid on those proceed but until you make withdrawals the money will grow tax deferred. Here are some advantages of a ROTH IRA.
First you must realize you can contribute up to $5,500 to a ROTH IRA and if you are over the age of 50 you are allowed a catch up of an extra $1,000 for both 2013 and 2014. If you are using a ROTH 401(k) you may contribute up to $17,500 a year and an extra $5,500 if you are over the age of 50. ROTH saving instruments are good though no matter what your age is and retirement is an important aspect of your life and one that it is never too early to plan for and take action on.
The biggest reason to use a ROTH investment is it is tax free when you make withdrawals after age 59 ½. If you need to make a withdrawal before that age and it is from a ROTH IRA that has been in place for at least 5 years you may withdrawal the principal without any penalty but that is not the case for a ROTH 401(k) as there is always a penalty for an early withdrawal of 10% plus taxes. That is not a good use for a retirement account so make sure you pay yourself first; but, also make sure you will not need the money prior to your retirement. Retirement and emergency funds are different and you do need both but in a pinch you can tap into a ROTH IRA if absolutely necessary.
And unlike a Traditional IRA where you have to start making withdrawals at age 70 ½ there are no age limitations on a ROTH IRA because you have already paid the taxes on the money in theory. But with a ROTH 401(k) you do have to start making withdrawals at age 70 ½ unless you are still employed with the company your 401(k) is with. And since you do not have to take mandatory withdrawals you can leave a ROTH IRA to children or grandchildren using the beneficiary mechanism which will allow your heir to take minimum withdrawals based on their life expectancy resulting in many more years of tax free growth. If you leave any IRA to someone through any means other than the beneficiary method your heir will only have five years to let the money grow before they are required to withdrawal the entire amount.
What if you are a high income earner? Simple use a Traditional IRA or a nondeductible IRA and then convert it to a ROTH and pay the taxes in the year of the conversion. But this can be difficult with various tax laws so it is best to consult a tax specialist when you go this route.