A Beginner's Guide to Roth Accounts
Does anyone else remember the commercial where a younger woman and her grandfather are in the car talking about retirement? Am I the only retirement nerd? Guess so. Anyway, the grandfather is on the phone, gets frustrated and says, “ROTH?!?! Who’s Roth?” I won’t go into the details of the life and times of Senator Bill Roth, but he helped change the landscape of retirement savings for everyone. Roth retirement accounts can be extremely beneficial when planning for your future.
First, let me explain how a Traditional IRA (Individual Retirement Account) works. A traditional account allows you to set aside money now without paying tax on it. You receive the benefit in the year you make the contribution, but it will be taxed when you take the money out of your account during retirement. The hope is that you are in a higher tax bracket now than during retirement, which may or may not be the case.
What makes a Roth IRA different is when you pay taxes. It allows you to pay tax now and never pay tax on that money or the gains again. These accounts allow your investments to grow tax free. For instance, let’s say you put away $5,500 a year in a Roth IRA starting at age 25 until you turn 65. You will set aside a total of $220,000 over the 40-year span and pay tax each year on the amount contributed. However, if you invest that money in the market over that time, your investments could grow to over $1.5 Million. You would never pay tax on that money when you withdraw it during retirement. Not too shabby!
Roth accounts are offered for IRAs and some employer 401k’s. Anyone can open a Roth IRA. There are income restrictions on whether you are allowed to make contributions. However, you can always convert money from a traditional IRA to a Roth IRA. You must pay tax that year on the amount you convert. Roth 401k’s are becoming more popular now. They are great because there is no income limit for annual contributions and you are allowed to put up to $18,000 in each year.
There are many other rules and differences to consider when choosing between Roth and traditional retirement accounts, but these are the basics. The most important factors are your age and tax bracket. If you are under 40 and/or below the 25% tax bracket, a Roth account will almost always be the better option. Tax rates can always change, but there is a sense of relief knowing that the money in your Roth accounts is all yours and will never be taxed again.
Don’t forget you can make contributions for the 2016 tax year until April 15, 2017!
Mike Zeiter, CPA/PFS