This post was inspired by a great movement that has been started and organized by one of the Yakezie bloggers, Jeff Rose. He blogs at Good Financial Cents and you can read more about the movement here
As it stands there are over 130 financial bloggers that are all writing about Roth IRAs and why we love them. We’ve all agreed to launch our posts, today, March 27th and discuss why they’re so important.
If you want to follow along on Twitter, check it out at #RothIRAMovement.
The driving factors that caused me to take part in this movement is two-fold:
1. It’s important for each person to save for retirement and the Roth IRA is a great vehicle to do that.
2. I have yet to talk about investing and retirement savings on this blog, so this opens up a great opportunity for me to start my 6-week series about investing and retirement planning!
So that’s why MANY Americans opt to contribute to a 401(k) instead of a Roth IRA. The 401(k) contributions come out before you ever see the money, so you’re not tempted to spend it.
If there is any downside to the Roth IRA, it would be found in your lack of discipline or inability to live well below what you make.
If you get confused with the terms 401(k), 403(b), 457, Traditional IRA, Roth IRA, SEP, SIMPLE, or TSP, then I’d encourage you to bare with me and check back next week as I’ll help you understand that better.
For now however, we’re going to focus on the Roth and why it’s SIMPLY AMAZING!.
There are four really important things that make this particular retirement account VERY special:
This isn’t some gimmick or a crazy scheme to out-smart the IRS. They’re well aware of this benefit and that’s why there are restrictions to it (keep reading).
There are only 3 investments that I’m aware of that offer this unique, TAX-FREE benefit:
1. Municipal bonds
2. Cash Value in Life Insurance if properly withdrawn
3. Roth IRAs!
The “Muni” bonds and Cash Value life insurance have hurdles, low rates of return, and do not offer anything near what a Roth IRA does, so imagine I never mentioned those.
Let’s take a look at a hypothetical situation to better grasp this whole TAX-FREE concept:
Sally Sue opens up a Roth IRA and contributes $5,000/year to it for the next 20 years. Assuming an 8% average rate of return over that 20 years, Sally would have $247,114 in her Roth IRA.
WOOHOO! That’s pretty impressive considering she only put in $100,000 of her own money!
Now, let’s also say Bob (Sally Sue’s husband) contributes $5,000/year to a Traditional IRA (or 401(k), 403(b), or 457) for the same 20 year period. Assuming the same 8% average return, it just so happens that Bob will have $247,114 in his account too!
Well, the big deal is that all of Sally’s earnings from her Roth IRA are FREE FROM TAXES!! That’s $147,114 that she made in interest that she gets to keep all to herself!
Poor old Bob on the other hand still has NEVER paid taxes on his contributions or his earnings. That leaves him knowing that ALL of the money in his Traditional IRA (or 401()k, 403(b), 457) is 100% TAXABLE.
Assuming Bob is in a 15% tax bracket in retirement, that means he really only has $210,047 and the remaining $37,067 is the government’s. Uncle Sam just did the Snoopy dance.
Assuming (for whatever ridiculous reason) that example isn’t enough to convince you that you NEED to contribute to a Roth IRA, here are a few others:
If you’re paying taxes TODAY on your Roth IRA contributions, then you know what they are.
The downside to the Traditional IRA, 401(k), 403(b), and 457 is that we have absolutely no idea what taxes will be 20 years from today.
I assumed 15% in Bob’s example above, but frankly I DON’T think that will be the case. The reality of our country’s dire financial situation suggest that taxes are going to go up.
If you want to gamble and hope taxes are still low 20 years from now, then that’s your call.
The reason for this is simply that they’re tired of waiting on their tax money. Remember, you don’t pay taxes on all of that money until you take it out.
On the other hand, you’ve ALREADY paid taxes on your Roth IRA contributions (and you don’t pay taxes on your earnings), so the government could care less when you take the money out.
The primary circumstance where this wouldn’t be the case is if you fall into the dreaded ESTATE TAX. Meaning, if your total estate is worth more than $5,120,000 (2012 limit) at the time of your death, then the estate tax applies to everything (including a Roth IRA).
If something sounds too good to be true, then it generally is. While that isn’t completely the case for a Roth IRA, there are some things that don’t make this the GREATEST thing since HD TV’s and smart phones.
Also, true to our American ways of loving to punish people that make too much money, the big part to Roth IRA income restrictions is that you can only contribute to one if you:
a) Have a Modified Adjusted Gross Income of less than $173,000 (2012 limits) Married Filing Jointly. There is actually a phase-out starting at $173k and ends at $183k.
b) Have a Modified Adjusted Gross Income of less than $110,000 (2012 limits) filing as a Single or Head of Household. Phase-out starts at $110k and ends at $125k.
If you’re over the age of 50 then there is a $1,000 catch-up provision, which means you can contribute up to $6,000/year per person.
The bottom line is that the Roth IRA should be viewed as a retirement account. Don’t touch the money…act like you don’t even have it!
As a financial advisor, as a person that understands the long-term effects of inflation, and also realizing that the end of Social Security draws nearer by the day, it has NEVER been more important for you to start contributing to your retirement AS SOON AS POSSIBLE.
Did I state that clearly enough? Let me try it again.
Regardless of your age and if you’re making money
The problem we face today is that many of us fall into the trap of living only for the here-and-now. However, the reality is that tomorrow will come…retirement WILL come…
The question is will you be ready and will you have saved enough to be able to enjoy it?
Keep coming back as I’ll continue to walk through retirement planning and investing over the next couple of weeks. Here is what you can expect:
Picture by 401K.
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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