There’s something cool happening across the Internet today. A huge chunk of personal finance bloggers are participating in the Roth IRA Movement. Basically it’s a movement started by Jeff Rose, who is a certified financial planner at Good Financial Cents. The goal is to get the word out about how great the Roth IRA is (and it’s great, I assure you).
I’ve been contributing to a Roth IRA for a number of years and am happy to have another way to diversify my investments from a tax perspective. So, what is a Roth IRA? It’s a great tool to help you save for your future without a future tax liability. You can contribute up to $5000 per year of your earned income (notice I said you have to have earned income?) to an IRA sheltered account. You use “after tax” money and all earnings and growth in your Roth account grow tax free. Once you reach age 59 and a half, you can withdraw any or all of the account value and face no tax liability. (You can always withdraw account contributions tax free but the gains need to stay in the account until you reach retirement or you will face a penalty). There are income limits if you make a ton of money, but for the majority of people out there, you likely qualify to participate in a Roth.
So, how is this different than a 401k? Well, it’s a lot different. In a 401k, you contribute pretax income to your account. This saves you the taxes in the year that the money was actually earned, but those dollars, along with any gains in your account, then face a tax liability when you withdraw the money at retirement. The HUGE drawback to this is that you don’t know what the tax rates will be in the future. In the US, with trillions and trillions in national debt, it’s probably a safe bet that the tax rates won’t be lower 25 years from now.
I actually use a ROTH in conjunction with a 401k. My thinking is that, if I have a substantial account value to draw from at 59.5, I can defer taking any distributions from my 401k longer, giving it more time to grow. It will also let me defer my pension a bit longer to maximize the payout. By building assets in a Roth IRA, I’m basically diversifying my tax liability by paying some now at the current “known” rates and paying some later (in my 401k).
Here are a few resources to learn about the Roth IRA:
What does Wikipedia have to say about it:
Info at the IRS: