What's so great about a Roth IRA?

It’s a question I hear a lot and the answer is: almost everything.

Let’s start with the basics. A Roth is a type of Individual Retirement Account (IRA) which allows you to save in a tax advantaged way even if your employer does not offer a retirement plan. The thing that differentiates the Roth from other types of IRAs (Traditional, SEP) is that the money you put into a Roth is put in after taxes are taken out which means that you’ll never pay taxes on that money again.

“No taxes?” you ask. That’s right. No taxes. That means if you contribute $40,000 to your Roth over the next 10 years and it grows to be $400,000 when you retire, you won’t pay a dime of taxes on that $360,000 that your investment earned.

Sound too good to be true? It really isn’t. Of course, there are a couple rules that you’ll have to follow.

Disadvantages

First, you are only allowed to put in $4,000/year (as of 2007, changes to $5,000 in 2008) and you have to have earned at least that much in income (unless you are an unemployed spouse in which case you can still contribute).

Second, there is a cap on how much you can earn each year and still be able to contribute to a Roth.

• Single: Under $95,000 = Full Contribution; $95,001-$110,000 = Partial Contribution; over $110,000 = No Contribution.
• Married filing Joint: Under $150,000 = Full Contribution; $150,001-$160,000 = Partial Contribution; over $160,000 = No Contribution.
• Married filing Separate: $0-$10,000 = Partial Contribution; Over $10,000 = No Contribution
  

* The above salaries are all your MAGI. MAGI stands for Modified Adjusted Gross Income and is an amount that is used for determining a taxpayer's IRA eligibility; it is generally the taxpayer's adjusted gross income (shown on IRS Form 1040 or 1040A) calculated without any IRA deduction, foreign earned income exclusion, foreign housing exclusion, student loan interest deduction, exclusion of qualified savings bond interest from Form 8815, exclusion of employer-paid adoption expenses from Form 8839, or deduction for qualified tuition and related expenses.

Third, since this is a retirement account, there are some rules for how and when you can get at your money without paying penalties and taxes. Luckily those rules aren’t too bad and the advantages make them worth it.

Advantages

First, as mentioned above, since you are putting in after-tax money, that money and all of the earnings grow tax free so when you access it in retirement you won’t have to pay taxes on it.

Second, Roth’s provide tax diversity in retirement. Because other retirement plans are taxable at income tax rates when you retire, having a Roth allows you to control how much you have to take out of those accounts and therefore control how much you pay in taxes each year. This can come in handy if you are on the border between two tax brackets.

Third, unlike other retirement accounts which require that you start taking money out at a certain age, with a Roth, if you don’t need the money you never have to take it. This means your money can continue to grow throughout retirement and you can leave a nice nest egg for your heirs.

Fourth, the Roth is much more lenient about letting you have access to your money before retirement. With a Roth you can take out your contributions at any time for any reason without taxes or penalties. Additionally, if your account has been open for 5 years, you can access your earnings without paying tax on them and there will be no penalties as long as you are using the money for a qualified reason:

• The distribution occurs on or after the Roth IRA owner reaches age 59.5.
• For un-reimbursed medical expenses
• To pay medical insurance (under specific circumstances)
• Due to disability
• As distributions to the Roth IRA beneficiary
• As part of an SEPP program
• For qualified higher-education expenses
• To purchase a first home
• For payment of Roth IRS levy

Fifth, there is no minimum age to start a Roth which means that if an 11 year old has a paper route they can contribute their earnings and start their retirement savings REALLY early. With the advantage of compounding, that is a great thing!

Conclusion

The Roth offers a great, user friendly way to save for retirement. It’s flexibility, tax advantages and other benefits make it an easy decision to participate and everyone who is able should be maxing out their Roth.