Why (almost) Everyone Needs a Roth IRA
While the childfree tend to have more money than our childed counterparts for the enjoyment of life’s pleasures, we must never forget to put some of that money toward retirement so that we can keep enjoying ourselves into old age, rather than subsisting on Ramen noodles after the age of sixty-five. One of the savings options Americans have is the Roth IRA, which is a type of IRA (Individual Retirement Arrangement). The primary benefit of a Roth IRA is its flexibility versus company retirement plans or traditional IRAs.
Those who most need a Roth IRA:
- If you are able to put more into an IRA than your contribution limit. At the typical IRA contribution limit, the difference between an IRA and a Roth is insignificant. Roth IRA’s perform better with larger contributions.
- If you plan to be in a higher income tax bracket when you retire than you are when funding your retirement. Take advantage of your lower tax status now so that you can live it up then. If you believe you will be in a lower tax bracket, consider a traditional IRA.
- If your company does not have a retirement plan or it just isn’t that good. If you have no plan, or your plan is poorly diversified, or with a bad group, an IRA can be a handy safety net.
- If you are single and your income will exceed $95,000 or are married and your income will exceed $150,000. Once your income reaches that level, you are no longer eligible for a Roth IRA.
The most compelling reason to open a Roth is that your contributions grow tax-free. This method of retirement savings is best utilized by the young since your contributions are from income that has already been taxed. Odds are, your pay will increase as you age and advance in your career, so investing while your taxes are lower is better in the long run. Once you put your cash away, it and the dividends it earns are yours tax-free, so long as you wait until retirement to use those dividends. Naturally, there are rules as to how much you can contribute per year. The most is $4,000; however, this amount is scheduled to go up in 2008. You cannot contribute more than your annual salary, and if your income is untaxed, you are not eligible to open an IRA.
The earlier you start saving, the more you will have at retirement, due to the financial magic of compound interest. A person who is twenty-five and contributes $10,000 will make more money by the time they retire than a fifty-year-old with the same $10,000. If you are just starting out, interest is your friend.
The table below shows what compound interest can do with the same one-time investment of $10,000 at five percent interest if a person were to invest at different ages.
| Age | Growth by age 65 |
|---|---|
| 20 | $89,850.08 |
| 30 | $55,160.15 |
| 40 | $35,863.55 |
| 50 | $20,789.28 |
If you are over the age of fifty, you are legally allowed to make additional contributions to an IRA, so a Roth may still be the option for you.
A Roth IRA is more flexible than most retirement plans. With a Roth, you can invest your contributions in stocks, real estate, bonds, and CDs. You need to research to find the right mix for you and your situation, but most people would prefer to have more control over where their money is invested, rather than blindly trusting the people responsible for their company’s 401(k) or 403(b).
The principal in your Roth can be used before retirement if necessary, and you will not have to repay such deductions, as you would with a 401(k). If, however, you take out earnings (interest) before age 59 ½, you will pay a 10% penalty and taxes on those earnings. If you use the money from your Roth IRA on your first house, you can take out up to $10,000 tax and penalty-free! Also, unlike a traditional IRA, you do not need to start taking money out once you reach 70 ½ if you do not need the cash.
With a Roth, the path to retirement and (dare I say) early retirement can be more secure. Start now, no matter your age, because the advantages are tremendous if you qualify. Remember, the more you save, the more you’ll have to live on in retirement while your friends fret about getting their kids through college.
Copyright . Published 1 January 2007 in Features.
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