Want Tax-Free Income for Life? Get a Roth!
Any type of IRA can give you a tax break while you save for retirement. With a regular IRA, qualified savers can get the tax break up front. With a Roth IRA, you skip the tax deduction now but won't pay tax on a single dollar of your investment gains once you begin taking qualified distributions. And, as you'll see, starting in 2010 these flexible savings vehicles get even better
What's so great about a Roth?
For young workers, a Roth IRA is a no-brainer:
- You're paying low tax rates now but may face higher rates as your income rises, even in retirement. So if you're in your mid-40s or younger, paying a little tax now on contributions and potentially getting a couple decades of tax-free compounded earnings can be a very savvy move.
- Roth IRA contributions aren't locked up until retirement. Contributions to a Roth IRA can be withdrawn tax-free for qualified distributions, which means you can access contributions in an emergency.
For workers later in life, there are advantages, too:
- Unlike a traditional IRA, you don't have to start taking money out at age 70-1/2 so your investment can keep growing tax free.
- You can continue to contribute to a Roth IRA in retirement, as long as you have earned income from a part-time job or other employment.
- Unique Roth features give you more flexibility in retirement and allow you to use a Roth IRA to pass money on to your heirs.
For a few folks, a Roth might not be the wisest choice for retirement savings:
- Workers in high tax brackets or with only a short time until retirement may find that a deductible IRA works out to be a better deal, depending on their tax situation and when they plan to start withdrawing money in retirement.
- People already covered by a 401(k) or another employer retirement plan, or those who make more than the rules allow, contributions to a traditional IRA aren't deductible. That makes a Roth IRA a valuable alternative.
Rules for Roths
Like traditional IRAs, the government sets rules around contributions and withdrawals from Roth IRAs, though the rules are different for the two types of accounts. The rules change a bit each year, so you should be sure to get the latest information before investing.
Changes for 2010
For years, income caps have kept Roth IRAs off-limits to high-earning taxpayers. Those limits are still in place, but starting in 2010, you can roll over a traditional IRA into a Roth regardless of how much you make. You'll have to pay taxes on the balance, of course, but you'll get two years to pay up—half in 2011 and the rest in 2012.
After 2010, you'll be allowed to immediately roll over traditional IRA contributions into Roth accounts. It's an extra step, but it effectively wipes out income limits for Roth contributions.
Is a Roth better than your employer's plan?
A Roth IRA is a great tool for retirement saving, but an employer-sponsored retirement plan is terrific, too. So which one do you choose? Both, say some financial planners. The tax-free qualified withdrawals of the Roth IRA and the tax-deferred wealth-building employer match of a 401(k) are a great complement to each other.
Skipping contributing to an employer-sponsored retirement plan to put all your money into a Roth would mean missing out on the matching contributions most employers contribute to the account. You also get a tax break on your contribution, since you don't pay any taxes on salary-deferral contributions until you withdraw them.
In a hypothetical case, an organization matches 50 percent of your contribution, up to 5 percent of your pay. A great first investment move is to contribute an amount needed to receive the full organization match in your organization-sponsored retirement plan.
After that, consider putting money into a Roth IRA. That can give you tax-free qualified distributions in retirement, so you'll have more options for managing your taxes and income once you stop working.
Take the next step...
Make savings simple! Simplify your retirement saving with an IRA.
