Does the Roth IRA make sense?

[shanecurran]

From my understanding a Roth IRA is preferred over a traditional IRA or other types of accounts 401K etc, only if you plan on being in a higher tax bracket when you retire (because taxes are taken out on the way in instead of on the way out). Is this true? When is it advantageous to invest in a Roth IRA?

[kork13]

Roth IRA's are also beneficial if you expect tax rates to increase (I'm betting on it). Also, keep in mind that once you contribute to the Roth, it's ONLY taxed on the initial contribution. Gains and dividends are not taxed--ever. So you can put in $5000, pay $1250 in taxes, and in 40 years it'll be worth $75,000 TAX FREE. Benefit? Absolutely.

Also, keep in mind that most 20- and 30-somethings will likely be in a lower tax bracket (due to lower income while still the "new" (-er) guy in the company/business/etc. Thus, it's a reasonable expectation that your income (and tax bracket) will go up over time, making the Roth even more beneficial, because you've locked in a lower tax hit than you would see with the same money decades from now.

[MonkeyMama]

Agreed with kork - the younger benefit more from the ROTH. If you invest well you come out further ahead.

When it comes to ROTH IRAs, you are ineligible to contribute if your income is too high anyway, so generally if you are eligible, the ROTH is the better bet. Maybe not so simple with 401k ROTH options, etc., since there may be no income limits. I wouldn't do a ROTH in the TOP tax brackets, myself. But that argument is pretty moot when it comes to IRAs.

As a tax professional, we love ROTHs. Once in a lifetime tax savings opportunity. The government doesn't offer tax shelters like this very often.

As far as taxes in retirement, there are a lot of nuances missed by the average person. For one, tax rates are currently very favorable to married folk. I continually see shock with my clients once they become divorced or widowed. Not only do they lose all their tax shelters in retirement, but going from married to single practically doubles your taxes overnight. I could flip a coin with my 60-year-old dad who is now eligible for ROTH contributions for the first time. I joke he should do the ROTH since I will inherit it. But it finally hit me and I told him, not to be macabre, that the ROTH would really have an edge if they contributed while married since could use the tax benefit when widowed. Even though he doesn't have a REALLY long savings horizon at this point, he does have a very low married tax rate for the moment. He's been out of work, so also converting IRAs over in the low tax (0% - 15%) bracket. Death and taxes, what can I say.

I think it's pretty safe to say taxes will go up for most people, in the long run. This is more true for younger people with more tax shelters and less income (Early in careers, etc.).

[Petunia 100]

I plan to use my Roth when I need to pay for big ticket items such as a new roof or to replace a vehicle, not for regular income.

Think about this: if you are using your traditional IRA/401k monies for your regular income and then need to pull out a chunk for some reason (say 20k for a new roof), you need to pull extra to cover the taxes, and from that point on, you have permanently lowered your regular income. (Assuming you are drawing x% of your nest egg per year).

IMO, it is a good strategy to have both Roth and traditional.

[kork13]

One thing I didn't mention... There is also a valid argument to doing BOTH -- Roth and regular (deductible) accounts. I have both a Roth IRA and a 401k-type account that I contribute to every month.

Part of the idea here is to spread your risk, and diversify your future tax exposure. By using both vehicles, you have the benefit of the tax free savings in the Roth, and the taxed savings in the 401k. This gives you the benefit of both.

That said, I prioritized the Roth over the 401k -- I was maxing out my Roth years before I even had access to the 401k-type account. Reasons for this are the same as already mentioned--the Roth is a great deal for young adults.

As a counterpoint, the Roth IRA is limited to only $5k/yr in contributions, versus the $16.5k/yr for 401k plans. So you can definitely save more in the 401k plan. Another great option: Roth 401k's -- best of both worlds! Tax-free growth/withdrawals, with a 3x higher contribution limit.

Honestly, the most important part is to just start saving ASAP. How you do that depends on your goals, expectations, and risk tolerances. Figure out what works for YOU, and do it.

[bjl584]

You can take advantage of the tax free aspect of your ROTH now, not just in retirement.

Example: I currently own a fund within my Roth paying out a quarterly dividend of 11%. It's all tax free money. Granted, I can't touch the gains until I retire, but it's all tax free until then. If I owned that same fund in my individual brokerage account I would be getting hit with a tax on it every year that I owned it.

[shanecurran]

I plan to use my Roth when I need to pay for big ticket items such as a new roof or to replace a vehicle, not for regular income.

Think about this: if you are using your traditional IRA/401k monies for your regular income and then need to pull out a chunk for some reason (say 20k for a new roof), you need to pull extra to cover the taxes, and from that point on, you have permanently lowered your regular income. (Assuming you are drawing x% of your nest egg per year).

IMO, it is a good strategy to have both Roth and traditional.

I also read that you can take pull out up to $10k for your first home purchase, is that correct? If so it would apply to me 28YO and renting. I do not plan on buying a home for at least 5 years or so.

[shanecurran]

Part of the idea here is to spread your risk, and diversify your future tax exposure. By using both vehicles, you have the benefit of the tax free savings in the Roth, and the taxed savings in the 401k. This gives you the benefit of both.

That is a great point that I never thought about-diversify future tax exposure. It is a bit of a catch 22 right now though, because I am in a perfect spot to contribute to the Roth IRA, but given my income level and the contributions I make to my 401K (which I have to make given 100% match up to 4% of my income) it is hard to set aside more money each month. I will make a goal to set aside some money each month though. I am new to the corporate world, but I am able to survive on my current income. I plan to follow disneysteves advice, but i plan on something closer to 50-50 split savings to spending on future income increases (at least in the short term, given the fact that I would like to upgrade to more reliable vehicle).

[shanecurran]

Another great option: Roth 401k's -- best of both worlds! Tax-free growth/withdrawals, with a 3x higher contribution limit.

Is this something that is normally (must) be set up by your employer?

[Slug]

Is this something that is normally (must) be set up by your employer?

Yes, but you can lobby for it. I have been lobbying my employer for the past 2 years. Eventually you'll be heard....maybe.

[bjl584]

Is this something that is normally (must) be set up by your employer?

It's normally offered by an employer. Mine just started offering a Roth 401K about a year ago in addition to the traditional 401K that they have been offering.

[mcfroggin]

Is this something that is normally (must) be set up by your employer?

No. If you own your own business, you can start one yourself.

[mcfroggin]

From my understanding a Roth IRA is preferred over a traditional IRA or other types of accounts 401K etc, only if you plan on being in a higher tax bracket when you retire (because taxes are taken out on the way in instead of on the way out). Is this true? When is it advantageous to invest in a Roth IRA?

Incorrect. Matching 401ks by an employer are usually more ideal than a Roth IRA. Some employers will actually provide >100% matches to a 401k. Its hard to say no to free money.

[mcfroggin]

When it comes to ROTH IRAs, you are ineligible to contribute if your income is too high anyway, so generally if you are eligible, the ROTH is the better bet.

There are ways around this. You can convert Traditional IRA's to Roth IRA's.

[mcfroggin]

One thing I didn't mention... There is also a valid argument to doing BOTH -- Roth and regular (deductible) accounts. I have both a Roth IRA and a 401k-type account that I contribute to every month.

Part of the idea here is to spread your risk, and diversify your future tax exposure. By using both vehicles, you have the benefit of the tax free savings in the Roth, and the taxed savings in the 401k. This gives you the benefit of both.

That said, I prioritized the Roth over the 401k -- I was maxing out my Roth years before I even had access to the 401k-type account. Reasons for this are the same as already mentioned--the Roth is a great deal for young adults.

As a counterpoint, the Roth IRA is limited to only $5k/yr in contributions, versus the $16.5k/yr for 401k plans. So you can definitely save more in the 401k plan. Another great option: Roth 401k's -- best of both worlds! Tax-free growth/withdrawals, with a 3x higher contribution limit.

Honestly, the most important part is to just start saving ASAP. How you do that depends on your goals, expectations, and risk tolerances. Figure out what works for YOU, and do it.

Solo 401k's will allow you to put $49000+/year in a tax free account if you qualify.