Bob O'Brien
Head Instructor
bobrien@mywealth.com
The Roth IRA is one of the most amazing savings tools ever created and not enough people are taking advantage of them. You literally get tax free growth! Keep in mind that there are not many things out there that are “tax free” in this world. However, the Roth IRA is one of them.
With the Roth IRA, you are allowed to put in $5,000 a year (6k if you are over age 50) with “after tax” money and this money grows tax free…not tax deferred. That means there will be NO TAX, assuming you draw out in retirement in which the account has been originally designed. It is definitely worth your while to see if you qualify for a Roth IRA in 2008 or 2009. Everyone will qualify in 2010, because there is no income limitation.
1. You can use both a 401k and Roth IRA. Many people confuse the Traditional IRA and Roth IRA rules and yet they are different. You can use the 401k to take yourself into a lower bracket like the 15% bracket, and then contribute to the Roth with money that is taxed in the lower brackets. Generally, you probably will not be able to use the Traditional IRA with a 401k.
2. You can use the Roth as a temporary emergency fund. Remember the principal in a Roth IRA can be drawn out without owing any taxes because it is “after tax” money. Many people should be looking to increase their emergency fund with the current state of the economy and this is a great place to do it. Invest in something like a money market account until you catch up with your emergency fund that is outside of your Roth IRA. You can contribute to a Roth IRA every year, and every year that you don’t, is a missed opportunity. Do you have a tax question for me?
3. Retirement distributions. Use the Roth to keep yourself in a lower tax bracket when you are drawing money out in retirement. You not only want to diversify your investments but you should also look to diversify the tax consequences of your retirement money too.
4. Invest in the Roth more aggressively. In point #2, I stated to invest the Roth conservatively when you have it as an emergency fund, but ideally you want to invest that money for the long term and make certain that you are more aggressive here since there will be zero tax due on your investment returns. Also, do not always automatically assume aggressive investing equals higher returns in the long run. Check out a blog that I wrote on this very topic: Volatility and your Money.
5. Consider converting your Traditional IRA over to a Roth IRA. There is an income limitation for this strategy of $100k for tax years 2008 and 2009, but there is no cap in 2010. This may make a lot of sense for some people and you definitively want to start thinking about it and running the numbers. You may have hefty tax bill at conversion, but it may be worth it for the long run. Check in with your CPA or CFP® to see what is best for your particular situation.
The Roth IRA is an incredible tool for building wealth. You can invest in almost anything you want to within a Roth IRA. So make certain, this tax season that you are finding out if you will qualify for the Roth IRA and what tax bracket that you will be in, in order to incorporate the best strategy for you. Here are a couple of links for further reading http://en.wikipedia.org/wiki/Roth_IRA and http://www.irs.gov/pub/irs-pdf/p590.pdf
Please feel free to post any comments and if there is blog topic that you would like to see in the future e-mail me bobrien@mywealth.com.
Sincerely,
Bob O’Brien
Sr. Instructor
