ROTH IRA ACCOUNTS

If you’re in your 20s, 30s or 40s, you should consider a Roth IRA. If you’re self-employed, you may only have an IRA as a retirement savings option available to you. And a Roth IRA can be a great option.

An IRA is an individual retirement account that is available to most people even if you already have a 401(k). The main advantage of a 401(k) is the company match feature, but the other benefits apply to IRAs as well:

• Pre-tax contributions that save on federal and state income taxes, and

• Tax-deferred growth over your entire working life.

A Roth IRA is different from a traditional IRA because contributions are made after taxes have been paid. But since the contributions are made “after-tax,” you don’t have to pay taxes on that money when you withdraw the funds in retirement. Not paying taxes on IRA withdrawals is a huge benefit.  Imagine not having to pay taxes on your income.  You can have that with a Roth IRA.

Typically, people in their 20s have a lower income than when they’re in their 40s. This means that the younger person would be in a lower tax bracket, let’s say 20% of their gross income. If this twentysomething contributes $800 to a Roth IRA, they must first pay $200 in taxes on the $1,000 in income it took to make this $800 contribution. They would therefore start $200 behind another twentysomething who made a $1,000 contribution to a traditional IRA. How can that be good?

Well, the advantage starts to accrue after the contribution is made and over the rest of the person’s working life (potentially 40 years). Forty years later, with average investment returns of 7.5% per year, that $800 would be worth $14,400.

In a traditional IRA, all of that $14,400 would be taxable once it’s withdrawn. With a Roth IRA, none of that $14,400 would be taxable. At a tax rate which at that point could be 25% or 30%, you would potentially pay $4,000 in taxes on that money in retirement, vs. the $200 in taxes you would have paid your twenties.

If your investment returns are higher, as they would be with a system like ours, the advantage is even greater. The $800 would grow to $95,500 with our system, not $14,400! In that case, the tax savings (due to the higher tax bracket later in life) could be over $25,000. The tax advantages are much less significant for people in their 40s or 50s because the Roth IRA contributions have less time to grow and because people in their 40s and 50s are typically in a higher tax bracket.

Anyone under the age of 45 should investigate a Roth IRA and see if it makes sense for you. It’s also possible to contribute to both a 401(k) and a Roth IRA. You can contribute as much as you need to in order to max out the company match in a 401(k), and also contribute to a Roth IRA as long as you stay within the annual IRS limits on contributions.

There are even situations and strategies that can work for Roth IRA conversions for people over 50.  These Roth conversion are fairly compled and you should consult a financial advisor to see if it makes sense for you.

Everyone’s tax situation is different, but you should see if a Roth IRA is right for you or you children.  Your Social Security income is taxable when you retire.  Your 401(k) and traditional IRA withdrawals are taxable when you retire.  But withdrawals from a Roth IRA are not subject to taxes.  Not having to pay taxes on retirement income makes it much easier and much simpler to manage your finances at this stage of your life.

Stay Disciplined My Friends,

Phil

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