Does the Roth IRA make sense?

[humandraydel]

Don't forget, a Roth IRA can reduce your future tax liability. Distributions from a Roth IRA during retirement do NOT count towards income, so you will owe less tax on social security income (as well as other income).

[kork13]

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.

That is one thing I didn't mention -- if you have a match, you should absolutely max out the match first, before doing anything else. (I don't have a match, so I don't normally think about it--sorry). If you've got a match, that's an immediate 50% gain on your money. You're not going to do better than that ANYWHERE. And if you can't save more than that match right now, that's fine. Just as you get pay increases, or reduce your living expenses, start slowly adding to a Roth.

In general, the order of priority in choosing which account to contribute retirement money to would normally be:
- 401k up to maximum match
- Roth IRA/Roth 401k to max
- Deductible 401k/IRA, SEP IRA, Solo 401k, etc (SEP/Solo are for the self-employed) to max
- Taxable investment accounts.

Certainly, your own investing strategy can/should change that. Say you've got a Roth 401k, but want to diversify your tax exposure, it wouldn't make sense to not contribute to your deductible IRA just because you aren't yet saving the $16.5k/yr into your Roth 401k. Likewise, you should consider opening a taxable investment account for making investments without the restrictions involved in using retirement accounts.

[kork13]

Don't forget, a Roth IRA can reduce your future tax liability. Distributions from a Roth IRA during retirement do NOT count towards income, so you will owe less tax on social security income (as well as other income).

A minor point, but a potentially significant one that I don't normally think about -- if you can reduce your taxable income to the point that you drop down in tax brackets, that would potentially be a significant boon to your retirement funds, by saving all of the extra money in taxes!

[disneysteve]

Another benefit to a Roth - no RMD. You are not required to take money out from your Roth and there is no guideline or minimum to how much you must take out or at what age you must take it. Traditional IRAs and 401ks have required minimum distributions. You must begin taking money out by the time you are 70-1/2 whether you need the money or not. Roths offer more flexibility and control especially if you don't need the money. You can let it keep growing tax-free for as long as you'd like and pass it on upon your death.

[humandraydel]

A minor point, but a potentially significant one that I don't normally think about -- if you can reduce your taxable income to the point that you drop down in tax brackets, that would potentially be a significant boon to your retirement funds, by saving all of the extra money in taxes!

Precisely! A lot of people overlook this benefit.

[mcfroggin]

A minor point, but a potentially significant one that I don't normally think about -- if you can reduce your taxable income to the point that you drop down in tax brackets, that would potentially be a significant boon to your retirement funds, by saving all of the extra money in taxes!

Minor because it often doesn't make sense to think about. If you drop from the 15% to the 10% tax bracket, you only save an extra 5% by using a Traditional IRA. That 5% is nothing compared to what you should return in a Roth account.

If you are already in the 33% tax bracket, a Traditional IRA would probably be more beneficial based on being in a high tax bracket. Who cares if it brings you down a bracket or not? You are already too high up to matter. A traditional would probably be better until you drop into a lower tax bracket in the future - then possibly convert to a Roth.

There is a very small window of income where dropping a tax bracket might benefit your IRA choices.

[kork13]

Minor because it often doesn't make sense to think about. If you drop from the 15% to the 10% tax bracket, you only save an extra 5% by using a Traditional IRA. That 5% is nothing compared to what you should return in a Roth account.

If you are already in the 33% tax bracket, a Traditional IRA would probably be more beneficial based on being in a high tax bracket. Who cares if it brings you down a bracket or not? You are already too high up to matter. A traditional would probably be better until you drop into a lower tax bracket in the future - then possibly convert to a Roth.

There is a very small window of income where dropping a tax bracket might benefit your IRA choices.

I was actually thinking that, in retirement, if you were to use an income (from IRAs/401k/etc) ordinarily in the 25% bracket but instead withdraw more from the Roth in order to drop down to the 15% bracket, that would be fairly beneficial -- saving 10% in taxes on every dollar above the 15% line ($34k/$69k). Definitely minor, and not something that will suddenly make retirement more affordable, but able to help.

[humandraydel]

I was actually thinking that, in retirement, if you were to use an income (from IRAs/401k/etc) ordinarily in the 25% bracket but instead withdraw more from the Roth in order to drop down to the 15% bracket, that would be fairly beneficial -- saving 10% in taxes on every dollar above the 15% line ($34k/$69k). Definitely minor, and not something that will suddenly make retirement more affordable, but able to help.

The 25% to 15% bracket change is my thinking as well as this is where a lot of retirees will be. The other benefit may be a little harder to achieve, but if you can get taxable income below $44k then only half of your social security is taxable.

No, you aren't going to be able to retire on the tax savings alone, but it could end up being an extra $3-5k per year. I'd certainly take an extra $300-400 a month since it is essentially free.

[Petunia 100]

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.

You can pull out your Roth contributions at any time with no penalty for any reason. (Not the earnings, only the contributions.) This is why your Roth can double as part of your emergency fund. You don't want to make a habit of this though, as you can not replace what you pull out.

The IRS allows a penalty free withdrawal from a traditional IRA of up to 10k for a first home purchase. You still pay the tax, you only escape the penalty.

[SeanH]

This stuff feels complicated even when I suppose it isn't.

I'm currently saving 25% of my salary into a 401k. This deduction eliminates all of my taxable income that would be in the 25% bracket. I've been doing the math all night trying to figure how my paycheck would look if I put 25% into a ROTH 401k instead of a traditional 401k. If I've done it correctly - I believe I end up with essentially the same paycheck, but I put ~$3k less into savings (~12k under the traditional 401k vs ~9<k with the ROTH 401k). That seems like it could be relevant 30 years down the road, but tax consideration does seem to lean hard towards the ROTH. I like that I can put far more money into a ROTH 401k than a ROTH IRA and that its straight forward through work as opposed to having to start up a new account (already have a Fidelity account, but keep hearing great things about Vanguard). Setting up a ROTH IRA though does give the nice home purchase as indicated above, but I get the feeling from reading this forum that retirements are for retiring on.

[krantcents]

Your understanding is correct! I don't think it is an either or choice. In my case I receive a pension, so I cannot have an IRA. Instead, I am contributing to a Roth IRA. I am hedging my bet that taxes may be higher when I retire.

[thesmartnickel]

Better investment decisions and higher returns will benefit more from a Roth IRA. Also, with the current economy, I bet a lot of people expect higher tax rates in the future (my generation will probably have to pay for some of the mistakes of this generation) which gives Roth an advantage over traditional.

[Banimal]

If I start contributing to a ROTH IRA now while my taxable income is less than 120k and say in 2 years my income jumps above 120k, I won't be able to contribute to it anymore?

[krantcents]

Since very few of us will not be in a higher tax bracket, the best reason for a Roth IRA is no requirement for minimum distribution and it can be inherited.

[Petunia 100]

If I start contributing to a ROTH IRA now while my taxable income is less than 120k and say in 2 years my income jumps above 120k, I won't be able to contribute to it anymore?

Yes and no. Right now, those who can't make Roth contributions due to income can make a nondeductible traditional IRA contribution, then convert it. (There is currently no income limitation on doing a conversion). Will this option always be available? No one can say for sure.