Take a Bite Out of Taxes with a Roth IRA
Most of us understand the main benefit of the traditional IRA: You avoid paying income tax today on the money you contribute. But there's another IRA in town: the Roth. Understanding the fine points of this "new(er) kid on the block" can mean big benefits when it comes time to retire.
Traditional IRAs vs. Roth IRAs
With a traditional IRA you get an up-front tax break on contributions and you don't pay taxes on earnings in your account until you start taking out the money in retirement. Also, you must start taking money from your IRA no later than age 70-1/2.
With a Roth IRA you don't get a tax break on contributions, and like a regular IRA, your earnings aren't taxed as they grow. But the biggest benefit comes later: You don't have to pay income taxes on qualified distributions in retirement. That's a huge plus, especially if you've had your Roth for many years and the money has grown well beyond your contributions. Also, Roths don't set an age limit for starting distributions, so your money can continue to grow tax free throughout your retirement.
Here's an example that shows the difference in cold, hard cash:
Assume:
- You have $4,000 to invest in an IRA
- Your money earns 7 percent a year over 10 years
- You are in the 25% tax bracket
If you invest in a traditional IRA:
- Income tax on the initial $4,000 investment: $0
- In ten years, your investment would grow to $8,038
- Income taxes on the $8,038: $2,009
- Total income tax paid: $2,009
If you invest in a Roth IRA:
- Income tax on the initial $4,000 investment: $1,000
- In ten years, your investment would grow to $8,038
- Income tax on the $8,038: $0
- Total taxes paid: $1,000
The net result: a savings of $1,009 in taxes — and even more if your tax rate was lower when you made the initial investment.
What about your employer's retirement plan?
Though the Roth IRA can be a terrific investment, that doesn't mean you should pass up your employer's retirement savings plan. That's especially true for plans where your employer matches a share of your contributions. Free money is a deal you should never pass up.
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Make savings simple! Simplify your retirement saving with an IRA.
