What Can A Roth IRA Do For You?

It’s a bird, it’s a plane, no it’s a Roth IRA.

The Roth IRA may be one of the best savings vehicles and secrets to your financial success.

Here are some of the nuts and bolts that you should know about the Roth IRA.

Roth IRA Tax Break

Contributions made to a Roth IRA are after-tax, meaning they don’t count as taxable income when you withdraw these dollars during retirement.  You have to be over the age of 59 1/2 and meet the five-year rule to avoid early withdrawal penalties.

Asset Location

Savings into a Roth IRA may help diversify your tax strategy and help control taxes down the road.  It’s called “asset location,” which is similar in context to asset allocation or diversification.  The focus is on where you hold your money from a tax perspective.

The Roth IRA Tax Strategy

The money contributed to a Roth IRA is considered earned income and is made with after-tax contributions.  An example of how this affects your taxes let’s assume you are in the 25% tax bracket today, each dollar that you contribute to your Roth IRA, 25% is taxed, and the remaining 75% will go into your Roth IRA.

When it comes time to retire, and those dollars come out tax-free.  While you already paid taxes on your contributions, you will not pay taxes on any growth inside the Roth IRA.

The Traditional IRA

Money going into a traditional IRA is pre-tax and tax-deferred. Meaning you won’t pay any taxes on the contributions, lowering your taxable income today.

That’s great — but what about in retirement?

You’ll pay taxes when you withdraw money from your traditional IRA in retirement.  And you’ll have to consider all your income sources and where your tax bracket may be.

The Gamble

If you believe that you’ll be in a higher tax bracket in retirement, the Roth IRA may be the better choice.

If it’s the other way around, then the traditional IRA may be your best bet.

But is it?  What if you’re investments do really well?  What if you have a really long time to invest?

Don’t rush to make this decision.

No Mandatory Withdrawals: While traditional IRA’s have required minimum distributions, often referred as RMD’s, at age 70 1/2, Roth IRA’s do not.

Caution: Roth 401(k) rules are different.

No Maximum Age: Roth IRA’s do not have maximum age limits on contributions, so as long as you have earned income and meet the income requirements, you can make contributions.

In contrast, traditional IRA’s will not allow you to make contributions past age 70 1/2, so saving into a Roth IRA can give you more of an opportunity to save later on in life.

Roth IRA Catch-Up Contribution

While the maximum contribution into a Roth IRA is $5,500, if you are older than 59 1/2 you can make a catch-up contribution of $1,000, making the maximum annual contribution $6,500. This gives you even more of an opportunity to save for your financial goals.

Of course, it’s the same with a traditional IRA.

Filing Status

If your filing status is single in 2014, you can make a maximum of $114,000 to make a full contribution and up to $129,000 to make a partial contribution; it is important to remember that we are talking about earned income. Any single individual that makes greater than $129,000 of taxable income is not eligible.

If you are filing as married, jointly you and your spouse can make up to $181,000 to make a full contribution and up to  $191,000 to make a partial contribution. Any married couple filing jointly that makes over $191,000 of taxable income is not eligible. For married couples filing separately, that has taxable income over $10,000 do not qualify to participate.

Five Year Wait Period

If you contribution to a Roth IRA you must wait five years or be 59 1/2 years old, whichever is longer, to be able to take money out without penalties. There are a few exceptions to this rule the will avoid the 10% early withdrawal fee but still be classified as earned income: death, disability needs, first-time homeowner, and college expenses.

You Must Have Earned Income

Anyone wanting to contribute to a Roth IRA must have earned income which is the income that comes from a 1099 or W2. There are a few instances where compensation could not be used for a contribution, which are rental income, profits from property maintenance, interest, dividends and other amounts that are not included in earned income.

Roth IRA’s give you the ability to make contributions for the previous tax year up until your April filing deadline. These benefits are very important when planning for your retirement. It is essential to sit down with your financial advisor and look at your full financial situation to determine what saving strategies are right for you.

 

These benefits are very important when planning for your retirement. It is essential to sit down with your financial advisor and look at your full financial situation to determine what saving strategies are right for you.

 

 

 

photo credit: Philip Taylor PT via photopin cc