Roths

Hello Everyone! Tonight I am going to finish our discussion on retirement savings. Last time we talked about IRAs and 401(k)s. Now we are going to talk about another type of IRA and 401(k) called a Roth. A Roth IRA has many similar characteristics to a traditional IRA except that it is funded with after-tax earned income. You may remember that one of the main benefits of an IRA is the tax-deferment (your money grows tax-deferred, no taxes are paid until it is withdrawn), so then why a Roth? The first benefit of a Roth is that the interest is tax-free. Therefore when you take a withdrawal you will owe no taxes because the principal was already taxed as income and the interest is tax-free! The second major benefit of a Roth is that it has more liquidity than a traditional IRA. You can withdraw the principal (the money that is contributed to the account, not the interest) at any time penalty free. This can be a big factor for young professionals, if you do not already have a lot of savings you may not want to tie of your money in an illiquid account in case of an emergency. There is a 10% penalty on early withdrawals of interest before the age of 59.5. You can also use Roth funds for some education, buying a home and health care. Therefore a Roth can be a great way to save for children's education. Another fact that you want to consider when you contribute to a Roth is your current tax bracket. If you are currently in a low tax bracket it may be a good time to contribute to a Roth instead of a traditional IRA, because hopefully when you retire you will have more income (and therefore a higher tax bracket) than you currently have! If you are currently in a high tax bracket, the tax-deferment of a traditional IRA may be better. However you never know what taxes are going to look like in 30 to 40 years from now when you retire. Therefore a good idea may be to have both a Roth and a traditional IRA so that you can diversify your tax liability. The annual contribution limit for a Roth is the same as a traditional ($5,000), but remember that this is for all of your IRAs. Therefore if you have a Roth and a traditional your totally contribution will be $5,000 per year NOT $10,000.

There are also Roth 401(k)s. In the case of a Roth 401(k) there will be two "buckets" of funds.    There is the traditional 401(k) "bucket" that the employer contributes to, and there is the Roth "bucket" that the employee contributes to. I am not going to get too much into this because you should have all the pieces to understand how this works. The contributions and employer match will be the same in a traditional 401(k), and the tax-free interest and after-tax principal is the same as the Roth IRA.

I hope that this is enough information to help you decide how you want to start saving for retirement. Remember it is never too early to start saving for retirement. 

Cheers,

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.