There’s been a lot of talk about Roth IRAs this year.
Some folks still aren’t sold on them – and of course no one particular investment vehicle is right for everyone.
But, for the right person, the Roth IRA is a great way to save some additional cash for retirement!
Here’s three important things to remember about investing into Roth IRAs.
You Can Access Your Principal At Any Time
This is a huge advantage! Your contributions are available to you at any point in time regardless of age and regardless of how long the money has been in the account.
Don’t confuse this with earnings. Only your principal is available, not any of your earnings.
Your earnings must stay in there until age 59 1/2 to avoid the 10% premature distribution penalty.
The great thing about this is that it makes the Roth a viable long-term investment vehicle, but also gives some flexibility in terms of needing to access the money for an emergency.
Of course, don’t start the Roth with this idea in mind – in other words, emergencies should be handled from your emergency fund, not from your Roth! But, it is nice to have this in your back pocket if you really were in a desperate situation.
There Are Income Limits
Yes, unfortunately there are income limits to these things. Of course, Uncle Sam doesn’t want any one and every one having the ability to max fund these things so they set limitations.
Generally, the IRS will phase you out of your contribution or reduce the amount you can put in if you make between two set amounts and then they will deny you a contribution altogether if you make too much.
In 2019, your Roth IRA contribution limit is reduced – or phased out in the following situations.
- Your filing status is married filing jointly or qualifying widow(er) and your modified adusted gross income (AGI) is at least $193,000. You are phased out completely if your modified AGI is $203,000 or more.
- Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.
- If you’re a single filer and your modified AGI is at least $122,000, you’ll be phased out up to $137,000. You cannot make a Roth IRA contribution if your modified AGI is $137,000 or more.
You Do Not Get A Tax Benefit Up Front
This one is pretty basic, but it bears repeating. It seems like a lot of people ask about how the Roth IRA works. The thing to remember is that your contributions are NOT tax-deductible. You do not realize any tax benefit up front.
So someone who contributes to a traditional IRA instead of a Roth IRA (provided they meet certain qualifications) gets an immediate tax savings equal to the amount of the contribution, multiplied by their marginal tax rate. Someone who contributes to a Roth IRA, however, does not get this immediate tax reduction.
Contributions to a Roth IRA do not reduce a taxpayer’s adjusted gross income (AGI). Compare that to a Traditional IRA where contributions reduce a taxpayer’s AGI.
Because you are using after-tax dollars for contributions, if you fund a Roth while in a moderate or high tax bracket, you will likely pay more income taxes on the earnings used to make the Roth IRA contribution than a Traditional IRA contribution.
This is simply because, as stated, contributions to traditional IRAs or employer sponsored tax deductible retirement plans result in an immediate tax savings equal to the taxpayer’s current marginal tax bracket multiplied by the amount of the contribution.
If you think your income in retirement will be lower, or that you will be in a lower tax bracket than what you are in right now, then that means you may be paying more tax on that money now than you would in the future. The higher your marginal tax rate, the greater the disadvantage.
Don’t forget though, that if you don’t diversify yourself from a tax standpoint you could be creating a huge retirement time-bomb for yourself!
What are your thoughts – Do the advantages of the Roth outweigh the disadvantages? Tell us your thoughts in the comments!
Yep, although the Roth has its strengths and weaknesses, I do think that the advantages outweigh the disadvantages. And just as the Roth has income limits for making contriubitions, the Traditional has income limits for receiving a tax deduction as well.
There is no age limit for contributing to a Roth. But with a Traditional, you can’t contribute after age 70 1/2.
Another great feature of the Roth is that there is no mandatory distribution age, whereas you must start taking distributions at age 70 1/2 with a Traditional IRA. So if you didn’t need the money, you could let it compound even further in the Roth and perhaps leave a bigger inheritance to your loved ones.
Darren´s last post ..How to Calculate Your Social Security Benefits
Darren – great point about not having to take mandatory distributions at 70 1/2 – this is a big advantage for folks who don’t really need the money since they avoid having to pay unnecessary taxes!
Jason @ Redeeming Riches´s last post ..How to Tell if Money Has Become Your Idol
I was just reading about Roth’s the other day. I really like them because you can take out your contributions at any time. If one plans on retiring before 591/2 (which I do) this will definitely come in handy!
myfinancialobjectives´s last post ..
You mostly cover this, but I thought I’d add that IF you are in the same tax bracket when you contribute and withdraw the money, there’s no difference in how much that money will be worth. E.g., Assume a 20% tax bracket, $100 to invest today, and withdrawal in 1 year. Also assume money grows at 5% / year.
If you invest in a Roth, you pay 20% taxes up front, invest $80, and in 1 year you have $84 to withdraw.
If you invest in a traditional IRA, you invest $100, it grows to $105 in a year. When you withdraw, you pay 20% tax, or $21, leaving you $84 to withdraw.
All that said, as you pointed out it is VERY important to diversify your tax position for your retirement, just in case the Government tries to pull a fast one.
Fred @ One Project Closer´s last post ..Review: Martha Stewart Living vs. Glidden Paint: Price, Quality, More…
The government, trying to pull a fast one? Say it ain’t so! ;)
For those with considerable amounts of cash in a traditional IRA that are considering converting to a Roth, keep in mind that there are significant tax considerations that one would have to pay up front in order to do it.
It takes quite a bit of courage to bite that bullet, but as I see it, you’ll be glad you did come retirement time.
I recently did this. And although it kinda hurt on the front end, I know it was the right thing to do.
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The part where you can access your principal at any time is what sold my wife and I on the Roth IRA. We are actually using ours to hold the money we will eventually use to purchase our house. Since it will be quite a awhile until we buy we thought it made perfect sense to hold the cash somewhere where we will be getting tax free growth, plus we’ll have that little bit there for retirement.
As an aside, the majority of our retirement savings goes to my 401k and her 403b. We won’t necessarily need the Roth money for retirement, but it makes for a nice way to save.
Money Infant´s last post ..Going To The Carnival
Fred, good point on the tax example. Again, I like to diversify from a tax standpoint.
Jason @ Redeeming Riches´s last post ..How to Tell if Money Has Become Your Idol