If you earn less than $183,000 this year, the Roth IRA may be the right choice for your retirement savings. In a previous post I presented three questions to help you determine whether you should contribute to a Roth IRA or the traditional IRA.
Below are ten reasons why I think a Roth IRA may be right for your retirement:
Your tax bracket may be higher in the future. The current federal income tax brackets range from 10% on the low end to 39.6% at the high end. Who knows what they might be in the future. Even if the tax brackets stay unchanged, your income could rise pushing you into a new, higher bracket. If you are on the low end of the scale today and expect to be in a higher bracket when you retire, then the Roth IRA makes sense.
Your income is too high to deduct a traditional IRA contribution. If you and/or your spouse participate in a retirement plan at work, your income may be too high to deduct a traditional IRA contribution. In this case, the Roth IRA might be your only option. Sometimes you just have to play the hand that is dealt you.
Roth IRA earnings grow tax-free. Under current tax law, earnings from Roth IRAs grow tax-free forever. While “forever” to Congress may mean about as much as a wedding vow from Zsa Zsa Gabor (married 9 times), the odds are that you will never have to pay tax on your Roth IRA gains, probably.
Roth IRAs have no required minimum distributions. Unlike traditional IRAs and other retirement accounts, Roth IRAs have no Required Minimum Distribution or RMD. This too could change in the future, but it’s unlikely. Even if Congress does enact an RMD requirement on Roth IRAs, it’s likely that existing Roth owners would be grandfathered in and the current rules would still apply. Beneficiaries who inherit Roth IRAs do have an RMD requirement, but their required distribution amounts are tax-free as well.
Roth IRAs pass tax-free to your beneficiaries. Not only do you get to enjoy tax-free growth on your Roth IRA investment during your lifetime, but your beneficiaries get to enjoy tax-free growth as well. Unlike a traditional IRA which is highly taxable, no income tax is due on your Roth IRA when it passes from you to your heirs. Required Minimum Distributions do apply to inherited IRAs, but the distributions are tax-free. Even with the RMD requirement on inherited IRAs, Roth IRAs present a huge opportunity to provide tax-free growth for multiple generations.
Principal can be accessed tax and penalty free. The IRS allows you to take the principal out of your Roth IRA tax and penalty free. It’s only the earnings that need to stay in until retirement. What’s more, it’s the principal that comes out of the account first. So if you have contributed $5,500 per year for 10 years and need to access your principal, you are free to take out up to $55,000 without taxes or penalties regardless of your age – even if your account is worth much more than that.
Roth IRAs allow for a do-over. Recharacterization is fancy IRS term that means you get to undo your Roth IRA contribution, if you change your mind. Recharacterizations must occur prior to October 15th of the year after the year the contribution was made. Generally, you may want to recharacterization if you have converted a traditional IRA to a Roth, but had a change of heart later, if your income for the year was higher than the Roth limits allow or the value of your investment dropped significantly after you made your contribution.
Roth IRAs offer “tax diversification” of your retirement income. Ideally you want your taxable income to be as low as possible. This is true in retirement, just as it is true now. One way to manage your future tax bill is to have sources of income that are taxed at lower rates like the current capital gains rate or better still, tax-free altogether like the Roth IRA. If all your income comes from pretax retirement accounts like pensions, 401(k)s and traditional IRAs, your ability to manage your taxable income in retirement will be very limited.
Roth IRAs are a great way to save for retirement AND college. Roth IRAs may help you bridge the gap between paying for college and saving for retirement. Since Roth IRAS are funded with after tax dollars, the principal can come out tax and penalty free for college or whatever you like. If you need money for college, you can use the principal from your Roth IRA. Don’t need all that money for college? No problem, just leave it in the Roth IRA and it grows tax-free for your retirement. In fact, if you really want to stretch it out, you could use any left over money in the Roth to fund your grandchildren’s IRA after you retire – all tax-free.
Roth IRA opportunities may be limited in the future. If you are thinking all this Roth IRA stuff is too good to be true, you might be right. The national debt sits at over $18 trillion and is growing every year. Sooner or later, the national debt will have to be addressed and Congress will need even more revenue. It’s possible, that a future Congress could limit taxpayers’ ability to save and invest tax free through Roth IRAs. Even if that doesn’t happen, your income could increase making you ineligible to contribute to a Roth IRA in the future. Once your income increases to above the threshold amounts, your Roth IRA opportunity may be over.
Roth IRAs won’t work for everyone. If your income is too high, or you don’t have earned income from a job or business, you won’t qualify to contribute to a Roth IRA. But if your adjusted gross income is below $183,000 a Roth IRA should be a part of your long-term retirement savings plan.
A Roth IRA distribution is qualified if you’ve had the account for at least five years and/or the distribution is made after you’ve reached age 59½, because of your total and permanent disability, in the event of your death or for first-time homebuyer expenses. Distributions made prior to age 59 1/2 may be subject to a federal income tax penalty. If converting a traditional IRA to a Roth IRA, you will owe ordinary income taxes on any previously deducted traditional IRA contributions and on all earnings. We suggest that you discuss tax issues with a qualified tax advisor.”