Eliminate Taxes With a Roth IRA

Rocketing national debt, unstable economy, high unemployment, and high inflation.  These are all factors that have Americans on edge right now.  What has the American public even more scared is the fact that the federal government has started to tap into public pension funds to pay for bankrupt social programs such as Social Security and Medicare.

So what’s a scared American to do?  Well, that’s where individual Roth IRAs are king. The combination of a private retirement fund and tax free growth is music to anyone’s ears.  I’ve said it time and time before that a Roth IRA is the fastest way to a million dollars for the average American.  The biggest factor contributing to this is that your money is taxed from day one through your paycheck and is never taxed again with a Roth IRA.

A Roth IRA is truly the “king” of retirement accounts.  Even 401k plans often pale in comparison.  One of the only reasons why a 401k makes sense is because many employers contribute to your account.  Let’s take a look at the tax benefit of a Roth IRA and why you should open one today.

ZERO taxation when you withdraw at retirement

This is the kicker for choosing a Roth IRA.  Not having to pay tax on withdrawals like you would with a 401k is simply astonishing to me.  As long as you are 59 1/2 years old and the account is five years old, you can withdraw any or all of your retirement savings tax free during your “golden years.”  This means all money in will stay in and will utilize the magic of compound interest.  With the uncertain economy a Roth IRA is a clear winner because who knows how high taxes will be 30, 40, 50 years from now…

You can remove your money invested at any time

If you are regularly putting money into your Roth IRA, you are able to withdraw your money invested without any penalty!  Most people don’t realize this, but it’s a huge selling point.  However, I don’t recommend doing this because you’re taking money away from your retirement account.  But, at the end of the day, it’s nice knowing your principal is accessible unlike money in a 401k.  what you’re NOT allowed to take out is the interest on your money. With a 401k you’re usually only left with a hardship withdrawal or a 401k loan. So, as long as you only take out money that you originally put it, you don’t get dinged with a tax penalty.

You can take it all out or leave it all in

No more worries about having to take out a portion of your money because of federal regulations.  Now, with a Roth IRA, you can leave your money in your account and let it keep gaining interest during your retirement.  This is a much appreciated feature because most people’s retirements last 15+ years.  You don’t even have to spend the money if you don’t need it! Unlike a 401k or traditional IRA, you are required to make minimum distributions once you reach 70 1/2.  If you have saved more than you had to, you can just leave the money in the accounts for your kids or whoever is set as your beneficiary.  This is huge for out of the blue deaths or just giving your grand kids a gift of money.

No age limit, no problem

I love that anyone can open a Roth IRA and contribute as long as they have some sort of income.  I first found out about them when I was 18 years old.  Boy, am I glad I found out about them then!  It’s great because you can open a Roth IRA for your kids and help the start investing at a young age and encourage stewardship habits early on.  At any age, it’s easier than ever to convert your traditional investment vehicles to a Roth.  If you’re young and in a relatively low current tax bracket I recommend switching and start enjoying tax free growth for life. Although there are potential pitfalls in converting, so make sure you understand the tax implications of doing a Roth IRA conversion.

Now that you know about the amazing tax benefits of a Roth-IRA, what are you waiting for? If you don’t have one, open one today. Here are a few great places to set up a free account:

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About the Author: Jon the Saver is a personal finance writer at Free Money Wisdom. His mission is to help you succeed in your personal finance life. When Jon is not writing on personal finance, he spends time with his girlfriend, lifts iron at the gym, and plays Scrabble.

19 comments
BarbaraWSimms
BarbaraWSimms

With Roth IRA, we are leaning more on the future. The idea of taking out money that is not taxed at all seems like a really good idea. Withdrawing from your account has fewer restrictions and penalty too.

Sofia2543
Sofia2543

Gary I just want to emphasize the good work on this , has excellent views and a clear vision of what you are looking for

Kevin@RothIRA
Kevin@RothIRA

Tax diversification is a poorly appreciated aspect of retirement planning. People throw most retirement assets into tax deferred vehicles, which can create a potential tax nightmare at retirement.

A Roth IRA provides a nice tax diversification play--at least some of your income won't be taxable when you begin withdrawals. That's doubly important when you consider that Social Security benefits are taxable based on other income.

Ryan @ Roth IRA
Ryan @ Roth IRA

Being a 20 something I've been raised to pretty much ignore the thought of social security by the time I reach retirement. A Roth IRA is something that I think every young person should start right away to alleviate the stress of their retirement in the future. Get a part time job now to fund it, and you'll be thanking yourself big time in the future.

Rimaye
Rimaye

Ryan, I was similarly raised to think that. However, after doing some reading, I've realized that as long as people are paying Social Security taxes, we will have Social Security benefits. But the idea that Social Security will not be around when you and I retire is convenient for people who don't like Social Security and want to dismantle it (a certain governor who refers to it as a "Ponzi scheme" comes to mind).

Jim
Jim

Didn't our president say on '60 Minutes' that if the federal government couldn't borrow more money that SS recipients might not get thir checks? If the government just prints new money to cover the bills then you get inflation. SS, if not reformed, will be drastically changed when the US government has to pay increasing interest rates to borrow. As we have seen with troubled European countries, when the bond markets change their mood on a country's debt, it happens quickly.

Kevin@RothIRA
Kevin@RothIRA

There will always be "what if" questions, such as those raised here, but preparing for the future based on the best that we know right now is all that we can do. With retirement we're talking 10, 20, 30, 40 years out so the possibilities of what could happen, ie changes in tax status of retirement plans, are always possible.

Jeremy, your advice on tax diversification is right on the money. We can't know what will happen in the future, so we need to spread retirement investments between fully tax deferred accounts (IRAs and 401Ks), partially deferred (Roth IRAs) and even non-retirement accounts. All have a place in retirement planning if for no other reason than that we don't and can't know exactly how things will play out.

Gary Rod
Gary Rod

Another question for the author, please:
The traditional IRA offers the up front tax incentive. How come we never see comparisons between that value, and the Roth? Plus, my investment counselor suggests I continue contributing to the traditional IRA, because I don't know what tax bracket I'll be in on retirement day. Because doesn't that retirement day tax bracket determine how much distributions on my traditional IRA will be taxed? And finally, politically speaking, what if the American economy is so bad in 10 or 15 years, and so many baby boomers lack funds, that the government allows easier, taxed reduced access to our IRA vehicles? Of course, they could react the opposite way, too, and tax the "h" out of us. What do you think?

Gary Rod
Gary Rod

Although this isn't an article about Social Security, your testimonial to it's solvency is missing 2 major points. First, the incredible amounts borrowed from SS (such as for Obamacare) are due, with interest, in the early 2020's. The CBO has projected that by 2020, the federal government has only a slim chance of paying back that debt. Secondly, as you partially made the point yourself, the withdrawals--which will only grow with greater numbers of retiring baby boomers--exceed payroll tax contributions. The surplus that is supposed to make up the difference has also been ransacked by the feds. You're placing too much faith in SS's solvency.

Rimaye
Rimaye

Okay, let's get some things straight - the government has "borrowed" from Social Security in the exact same way that it borrows from investors, i.e. via Treasuries. There is no more risk that SS will not be paid than that Goldman Sachs won't be paid (unless politicians decide to selectively default on SS-held Treasuries only, but that would be a purely political move and a suicidal one at that).

While you cite "Obamacare," the biggest contributors to budget deficits in order are (1) the Bush-era tax cuts, (2) the wars in Iraq and Afghanistan, (3) the recession, and (4) the stimulus. If you actually read the CBO reports, you'd know that "Obamacare" is actually projected to *reduce* the deficit in the long-term by reducing health care costs.

All of this is easily verifiable and backed by analysis. But, as the saying goes, "a lie repeated often enough becomes true."

Jeremy
Jeremy

Gary, you bring up some good points. This is why I, and most advisors will recommend tax diversification as well. Just like how you diversify investments because you can't predict the future, it's wise to diversify your tax liabilities as well. So if possible, it's a good idea to have money in different types of accounts so that you can react accordingly and minimize your tax burden in the future.

Nobody knows for sure what will happen in the decades to come, so what might seem like a no-brainer today could end up being a less advantageous option thirty years from now. So, instead of betting the farm on a single potential tax outcome, if you have various pools of money with different tax consequences to pull from, you'll hedge your bets a bit and be able to structure your withdrawals in a way that minimizes your tax burden if possible.

Rimaye
Rimaye

Great info about Roth's - I have one and max my contributions every year. But I take issue with one thing you said in the beginning:

"What has the American public even more scared is the fact that the federal government has started to tap into public pension funds to pay for bankrupt social programs such as Social Security and Medicare."

Hold on a minute. Social Security can't go "bankrupt." It is starting to pay out more in benefits than it takes in via payroll tax, but thanks to the surpluses that have accrued for years, it won't be out of cash until 2036 or so (according to CBO projections). And when that happens, all it means is that it won't be able to pay out more than it takes in for that fiscal year. Your advice on Roths is spot-on, but it'd be great if we could avoid repeating the half-truths that are circulating in the media and promoted by certain interests that would like to dismantle social safety nets.

Laura
Laura

The politicians aren't stupid. When the 401k was invented, it took them awhile but eventually they created the Roth because they needed money NOW. Then when people start using the income from the Roth, the government will need money right then n there again so they will switch to a sales tax way of collecting taxes like Europe. So you will have to pay taxes on it again. So don't be naive enough to think you've outsmarted them.

Jeremy
Jeremy

Jared, in 2011 for a married couple filing jointly the ability to contribute begins to phase out at a MAGI of $169,000. You cannot contribute at all above $179,000.

Jared
Jared

PS - So if I start contributing now to the Roth but for some reason come to the end of the year and have an AGI above the cap, what happens with the IRS? Is there a penalty or do any gains in the fund have to have taxes paid on them? Just want to understand the full ramifications before I go and dump money in the account.

Jeremy
Jeremy

If you contribute money and then find out at the end of the year you've made too much money, you can recharacterize what you contributed and any gains you had to a non-deductible IRA. You'd pay taxes on any gains realized during that time, but you'd avoid any penalties and such.

Jared
Jared

Jeremy - Thank you. That is as cut and dry as it gets. Appreciate the response!

Jared
Jared

Love the posting and have a Roth open with ING right now because it was so easy to open when I opened an investment account with them. Thing is though, I can't figure out if I'm allowed by IRS guidelines to actually put money in it. My wife and I are currently DINKS with pretty solid professional jobs in the medical field (not Dr's though), so our tax bracket is up there. I have not been able to locate a steadfast answer to the question of, what's the salary cap on the Roth...all the sites I have visited are wishwashy and thick with the typical IRS legal-sleeze. What's the final answer on income limits on the Roth?

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