Roth IRA: The Great Retirement Diversifier

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I cannot stress enough the importance of socking away as much money as you can for retirement as early in your working years as possible. If your employer offers a sponsored retirement plan, at the very least, you should be contributing enough to receive any match that the company offers.

These types of accounts can offer a powerful tax benefit during your working years, since they are tax-deferred.

Yet often overlooked is the impact income tax has on your retirement nest egg. Deferring taxes is beneficial, but you should also look at ways to allow for tax-free income during your retirement as well.

Roth IRAs offer the opportunity for post-tax savings. With a Roth IRA, your contributions are made after tax, which means that although you don’t get an initial tax deduction, earnings on your investments grow tax-free and can be withdrawn tax-free during retirement.

Another big advantage of a Roth is that, unlike 401(k)s and Traditional IRAs, a Roth is not subject to minimum distributions at age 70½. And with many of us living longer, this is an excellent way to be able to continue taking advantage of tax-free growth well into your golden years.

Roth IRAs can also be an excellent savings vehicle for younger people who want to lock in their tax rate, while they are early in their careers and in a lower tax bracket. Although it’s difficult to forecast what tax rates will likely be in the future, it’s not hard to imagine that taxes may go up. So aim to stash away the maximum the IRS allows per year, which is currently $5,500, and for those 50 years old or older, try to add to that the additional $1,000 per year you are allowed.

Not surprisingly, because of the huge tax benefits that Roth IRAs provide there are a fair number of rules that must be followed. For instance, you are not eligible to contribute to a Roth IRA if your adjusted gross income is over $196,000 as a joint tax filer or $133,000 as a single filer.

Roth IRAs can be very helpful for individuals who do not have the opportunity to participate in an employer sponsored retirement plan (such as freelancers, entrepreneurs and 1099 employees).It is also helpful for those who have fully contributed to their employer-matched program and want to continue saving. But, keep in mind that it is wise to take advantage of any matching dollars from an employer sponsored program first, before contributing to a Roth IRA.

If you do have an employer-sponsored retirement plan, check with the plan administrator to learn if a Roth 401k/403b option might be available. If this is the case, you can allocate a percentage of your wages to a bucket that is tax-deferred and a percentage to a bucket that is taxed immediately but will grow tax free and be withdrawn tax free. Later, when it is time to retire, your 401k/403b can be rolled over into an IRA and your Roth 401k/403b can be rolled into a Roth IRA.

Although Roth IRAs can be a good method for achieving tax diversification, there are other options as well, once you hit your contribution limits. There are a number of tax management techniques, in addition to traditional employer sponsored or brokerage retirement accounts that individuals or families with complex planning needs may want to consider. Working with a professional, who can discuss with you your specific situation and what range of options may be available, is always a good idea.

One of the things that I emphasize with my clients is that the measure of success of any financial plan is not just how much income you generate, but more importantly how much of that income you are able to keep, after taxes, in retirement.

Feel free to contact our office if you have any questions or if you would like to discuss how a Roth IRA may help you achieve your financial and retirement goals.