Many people have the misconception that Roth IRAs (or Traditional IRA) are a type of investment. Well, they are an ‘investment’ in your future, but they are not an investment like a stock is an investment. They are merely an account type much like a checking account is a type of an account, but they enjoy special tax characteristics.(1)
I personally prefer a Roth IRA over a Traditional IRA because I’m a young saver with hopes to be in a much higher tax bracket by the time we retire (read higher tax bracket = filthy rich). Additionally, with our savings outside of our Roths, we can spend down those assets first in retirement and can leave the money in our Roth as long as we need, so we can maximize the tax-free benefits of the Roth.
Key points of differentiation between a Traditional IRA and Roth IRA:
- A Roth IRA is contributed to with after-tax dollars (you pay payroll (Social Security & Medicare) and federal income tax on the money in the year you earned the income), but the money grows tax-free and you will never pay taxes on what is earned within a Roth.(2) Additionally, you can defer taking money out of a Roth IRA indefinitely.
- These accounts are best if you think you will be in a higher tax bracket in retirement (believe it or not, income tax rates – especially the top tax rates – are at historic lows), and/or if you prefer to spend down other assets first.
- A traditional IRA is tax deductible (typically – with some limitations) in the year of a contribution, but you must pay income taxes on it when you take money out. Also, you must begin taking distribution out beginning at age 70 1/2.
- These accounts are best if you need or want the tax deduction now and expect to be in a lower tax bracket in retirement.
Tips to help in your quest for savings:
1) Set up a Roth today: Consult your financial planning professional for more information or consider managing our your own account at a company like: Vanguard, Fidelity, TD Ameritrade, etc.
2) Know what you can contribute: For 2012, you can contribute $5,000 ($6,000 if over the age of 50) to a Roth IRA provided your income is less than $173,000 for married couples and $110,000 if you are single.(3) Even if one spouse doesn’t work, you can potentially contribute to a Roth IRA for both individuals and sock away $10,000. Haven’t contributed yet? There’s still plenty of time.(4) You have until the tax-filing deadline in April 2013 to make a contribution for the 2012 tax year.
A Roth is a really approachable way for individuals to begin saving at a higher level.
(1) You can open a Roth account at a bank, credit union, or brokerage firm (Schwab, Fidelity, Scottrade, eTrade).
(2) http://www.irs.gov/publications/p590/ch02.html#en_US_2011_publink1000231057. Provided the IRS doesn’t change their tax treatment in the future.
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