Like so many savings plans, Roths work best when you start them young. Happily, "young," by my age scale, includes working people in their early 50s. Older working people should consider them, too.
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Both Roths and traditional IRAs are basically savings accounts with good tax breaks, which makes them an excellent place to stash cash for your retirement. You can sock away up to $5,500 in an IRA this year — $6,500 if you're 50 or older.
You can make the full annual contribution up to a certain income level. For traditional IRAs, that's currently $59,000 for singles and $95,000 for marrieds. For Roths, it's better — $112,000 for singles and $178,000 for marrieds. After that, the allowed contributions gradually decrease to zero.
Here's what Roths offer compared with traditional IRAs:
1. Easy access to your money, at any age.
You're allowed to withdraw your personal contributions whenever you want, without paying taxes or penalties. If you put $1,000 into a Roth on Monday and suddenly need some cash on Tuesday, you can take that $1,000 right out again. So your Roth can be both a retirement account and a ready savings account. Traditional IRAs don't allow free withdrawals.
2. Retirement income, tax-free.
There's no tax deduction for the money you put into a Roth. Instead, the money you earn on your investments comes tax-free when you retire. To get this tax break, you generally have to hold the Roth for at least five years and be older than 59-1/2. If you're in a high tax bracket and expect to drop to a lower one when you retire, you might prefer the traditional IRA. In a traditional plan, your contribution is deductible on your current tax return. On the other hand, you might be in a high bracket when you retire, especially after age 70-1/2 — the age when people who hold traditional IRAs begin mandatory withdrawals. Future tax rates are a guessing game. They're one factor, but not the only one, that enters into the Roth decision.
3. Tax-free wealth for your heirs.
Roth accounts are terrific for people who expect to leave at least some of their IRA savings to their heirs. People who inherit traditional IRAs owe income taxes on the money. Roth IRAs come income tax-free and could grow, tax-free, for two or three generations.
4. Opportunity to increase your wealth at older ages.
You don't have to make withdrawals from a Roth. Traditional IRAs force you to start withdrawals at 70-1/2. If you work past 70-1/2, you can continue contributing to a Roth but not to a traditional IRA.
5. Potential savings on future Social Security taxes and Medicare premiums.
You owe income taxes on part of your Social Security benefits if you're single with an adjusted income of at least $25,000, or married with $32,000. Your "income" includes withdrawals from a traditional IRA, which — at 70-1/2 — could be large. Money withdrawn from a Roth, however, is exempt from this calculation, which holds future taxes down. Roth withdrawals also are exempt from the calculation that charges wealthy people higher premiums for Medicare. In this context, "wealthy" means adjusted incomes over $85,000 for singles and over $170,000 for married couples.
6. Larger annual contributions.
If Roths are offered within a company 401(k) plan, you can contribute up to $17,500 this year and $23,000 at 50 and older.
7. An option to roll over any amount of money from a traditional IRA or 401(k) into a Roth.
You might not want to do this because you'll owe income taxes on the amount transferred. But James Lange of the Lange Financial Group says the switch makes sense if you think your tax rate will be about the same or higher when you retire and you can pay the tax with non-IRA funds. Paying with IRA funds would deplete your "tax-favored" savings. So you might consider rolling over a modest amount each year.
8. A great gift for kids.
If your children or grandchildren can't afford to contribute to a retirement plan, you can start a Roth for them.
Jane Bryant Quinn is a personal finance expert and author of Making the Most of Your Money NOW. She writes the Financially Speaking column for AARP.