There's been a lot of talk about Roth IRAs this year. Some folks still aren't sold on them – and of course no one particular investment vehicle is right for everyone.
But, for the right person, the Roth IRA is a great way to save some additional cash for retirement! Here's three important things to remember about investing into Roth IRAs.
You Can Access Your Principal At Any Time
This is a huge advantage! Your contributions are available to you at any point in time regardless of age and regardless of how long the money has been in the account.
Don't confuse this with earnings. Only your principal is available, not any of your earnings. Your earnings must stay in there until age 59 1/2 to avoid the 10% premature distribution penalty.
The great thing about this is that it makes the Roth a viable long-term investment vehicle, but also gives some flexibility in terms of needing to access the money for an emergency.
Of course, don't start the Roth with this idea in mind – in other words, emergencies should be handled from your emergency fund, not from your Roth! But, it is nice to have this in your back pocket if you really were in a desperate situation.
There Are Income Limits
Yes, unfortunately there are income limits to these things. Of course, Uncle Sam doesn't want any one and every one having the ability to max fund these things so they set limitations.
Generally, the IRS will phase you out of your contribution or reduce the amount you can put in if you make between two set amounts and then they will deny you a contribution altogether if you make too much.
In 2010, your Roth IRA contribution limit is reduced – or phased out in the following situations.
- Your filing status is married filing jointly or qualifying widow(er) and your modified adusted gross income (AGI) is at least $167,000. You are phased out completely if your modified AGI is $177,000 or more.
- Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.
- If you're a single filer and your modified AGI is at least $105,000, you'll be phased out up to $120,000. You cannot make a Roth IRA contribution if your modified AGI is $120,000 or more.
You Do Not Get A Tax Benefit Up Front
This one is pretty basic, but it bears repeating. It seems like a lot of people ask about how the Roth IRA works. The thing to remember is that your contributions are NOT tax-deductible. You do not realize any tax benefit up front.
So, someone who contributes to a traditional IRA instead of a Roth IRA (provided they meet certain qualifications) gets an immediate tax savings equal to the amount of the contribution multiplied by their marginal tax rate while someone who contributes to a Roth IRA does not get this immediate tax reduction.
Because you are using after-tax dollars for contributions, if you fund a Roth while in a moderate or high tax bracket, you will likely pay more income taxes on the earnings used to make the Roth IRA contribution than a Traditional IRA contribution.
This is simply because, as stated, contributions to traditional IRAs or employer sponsored tax deductible retirement plans result in an immediate tax savings equal to the taxpayer's current marginal tax bracket multiplied by the amount of the contribution.
If you think your income in retirement will be lower, or that you will be in a lower tax bracket than what you are in right now, then that means you may be paying more tax on that money now than you would in the future. The higher your marginal tax rate, the greater the disadvantage.
Don't forget though, that if you don't diversify yourself from a tax standpoint you could be creating a huge retirement time-bomb for yourself!
What are your thoughts – Do the advantages of the Roth outweigh the disadvantages? Tell us your thoughts in the comments!