Beating the Tax Gods: The Roth IRA

Hey there Money Saver! Welcome back to another week of How to Save A Buck, where we explore ways of saving money in personal finance, credit cards, and investing!

Whoever said “Nothing in life is certain except death and taxes” clearly didn’t have a Roth IRA.

So let’s rip open the Roth IRA and examine how this tool can allow investors to invest for retirement and decrease taxes later on. It’s possible you don’t even have one. As of 2021, only 37% of US households have an IRA.

Ladies and gents, please welcome the Roth IRA - where your money grows faster than a beanstalk and the IRS can’t touch it!

What is a Roth IRA anyway? It’s an individual retirement account (IRA) you contribute to with after-tax dollars. You then invest those dollars into assets of your choice, such as stocks, mutual funds, etc. Your contributions and investment earnings grow tax-free. Once you hit age 59 ½, and have held the Roth IRA for at least five years, you can take distributions from your account without paying federal taxes!

Now that’s a win!

In 2023, the maximum annual contribution for a Roth IRA is $6,500, or $7,500 if you’re age 50 or older. (This is up $500 from 2022.) These contributions can be made through April of 2024. That’s right - you have until April of the following year to make your contribution for the previous year - a process I use because I want to make sure I fall in line with the thresholds.

Most firms like Fidelity or Vanguard allow you to mark the contribution for the previous year in their user interface.

People with modified adjusted gross incomes below $153,000 (single) or $228,000 (married filing jointly) in 2023 can contribute to a Roth IRA, though income phase-outs may reduce your maximum contribution. In 2024, the numbers increase to $161,000 (single) or $240,000 (married filing jointly).

So, if you feel you may be close to those thresholds, just wait until you file your taxes and then if you fall within, make a contribution for the previous year.

You can see where I’m going with this - the Roth is a hell of a deal!

The HUGE benefit of the Roth IRA is tax-free growth - on both the contributions and the earnings that accrue over the years. If you play by the rules (and I’ll assume you do 😉), you won’t pay taxes when you take the money out.

You can begin making those tax-free withdrawals at age 59 ½ if you’ve had the account open for at least five years.

Roth IRAs have a few unique advantages as well:

1. You can withdraw your contributions anytime, for any reason, without incurring income taxes or penalties.

2. In certain situations, you can withdraw earnings early without paying penalties, like for a first-time home purchase.

3. You pay no income taxes on qualified withdrawals from a Roth IRA.

4. Roth IRAs are never subject to mandatory RMDs (inherited Roth IRAs may have RMDs).

If you’re still in your twenties or thirties, Roth IRAs are particularly attractive. You have a longer time horizon, so the impact of compounding growth benefits even more. And since younger people tend to be in lower tax brackets, the tax-free withdrawals in retirement can be a huge advantage.

Example: You’re 30 and in a 20% tax bracket. You plan to retire at 65, anticipate a 7% annual return, max out the Roth contribution each year and begin with $10,000. What do you end up with?

The Roth generates $275,032 more than a taxable account!

So, if you’re starting out in your investing career, consider the Roth as another retirement vehicle. It’s like a magical piggy bank that keeps growing, and when it’s time to break it open, all the coins inside are yours to keep, tax-free!

So, the certainties in life are death and taxes.

Let’s re-phrase it. The certainties in life are “Death, taxes, and a tax-free retirement account option!”

Save On,

Chris