Rick Welch: Dollars and $ense

“Is a Roth IRA right for me?”

The Roth IRA, named for its principal legislative sponsor Senator William Roth of Delaware, was established by the Taxpayer Relief Act of 1997. Roth accounts, which include both tax-sheltered individual retirement accounts (IRAs) and company sponsored 401(k) savings plans are funded by after-tax dollars (and are not tax deductible) in contrast to the pre-tax dollars (which are deductible) contributed to the traditional versions of these plans. In 2015 the limit on annual IRA contributions (to all IRAs) will again be $5,500 (or $6,500 if you are 50 or older). Contributed assets in both the Roth (after-tax) and Traditional (pre-tax) plans grow tax free. After the age of 59 ½, withdrawals from Roth accounts are tax free while withdrawals from traditional plans are taxed at your then current income tax rate.

The first question you should ask is whether it is better to get a tax deduction now for contributing to a traditional plan or to put after-tax dollars into a Roth account and take tax-free withdrawals at a later date. Focus on whether you can expect your tax rate at time of withdrawal to be higher than your current tax rate – if yes, then a Roth might be a good choice for you. In general, Roth accounts are more appropriate for young savers (30 and under) than for savers in their peak earnings years.  The adjusted gross income phase-out ranges for Roth accounts, $116,000 to $131,000 for singles and $183,000 to $193,000 for married couples, are much higher than the phase-out limits for traditional plans. If your income rises above the Roth phase-out range later (and you are no longer eligible to contribute to your Roth IRA), just leave your money where it is and watch it grow tax-free until withdrawal.

Roth accounts offer a great deal more flexibility than do traditional plans.  An early withdrawal (before age of 59 ½) from a traditional IRA will often incur both income tax and a 10% penalty – with a Roth, early withdrawals can be made without penalty. Many young savers consider their Roth a great option as an emergency fund or for milestone events like buying a home or starting a business. Two other major benefits of a Roth are enjoyed by the saver upon turning 70 ½, the age at which contributions to a traditional IRA must stop and required minimum distributions (RMDs) must begin.  In contrast, with a Roth account you can continue to invest past the age of 70 ½ and are never required to make any withdrawals.

If you are not eligible to contribute to a Roth IRA and are unable to make Roth contributions to your 401(k) plan, then another way to take advantage of the benefits of a Roth IRA is to convert some or all of your traditional IRA money to a Roth.  Eligibility for a Roth conversion is just one factor to consider in addition to your future income tax expectations, when you will need to access your money and the ability to pay the income tax due upon conversion from sources other than your IRA.  High net worth individuals, with a large IRA balance (of money that is not needed in their lifetime), may look to reduce their gross estate (by paying income tax on conversion) and leave their heirs an inheritance that could grow tax-free and be withdrawn over their lifetimes.

Investing in a Roth IRA has both its advantages and disadvantages. Pay more income taxes now and get added flexibility and freedom down the road. A registered investment advisor (RIA) can help you determine if a Roth is a good match for you, your current circumstances and your longer term investment and retirement planning horizons.

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