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To Invest in a Roth or Not?

03/29/10 by  
Filed under Bourbon & Bayonets

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While the title of this article could stir many a great rock ‘n roll debate about the front men of Van Halen, we’ll focus on investing for retirement.  Americans are not saving for retirement as much as they once did.  The frugality of “the Greatest Generation” has steadily given way to the excess of later generations.  One way to save more is with the Roth IRA, which remains a mystery to some investors despite being a great way to save for retirement.  Today we will try to de-mystify it.

Named after the late Senator William Roth of Delaware, the Roth IRA is a federally structured retirement plan.  It usually serves as a supplemental retirement plan to Americans with employer-sponsored retirement plans.  However, it can be used as a primary retirement savings vehicle in certain situations.  A Roth could be perfect for some people.

Several attributes of the Roth IRA distinguish it from other retirement plans.  For one, Roth contributions have already been taxed.  In other words, you cannot deduct contributions in your current tax year with the Roth.  The upside is that direct contributions to those accounts can be withdrawn tax-free at any time.  The real benefit happens after 59½ – when all monies in the Roth IRA are tax-free.

This is the primary difference between Roth IRAs and Traditional IRAs.  Contributions to traditional IRA’s are tax deductible at the time of contribution.  However, you must pay tax on your distributions during retirement.  You decide whether you want to pay taxes now (with the Roth IRA) or later (with Traditional IRAs).

However, not everyone can contribute to a Roth IRA.  Eligibility phases out at certain income limits.  For single filers, you cannot make more than $105,000 to qualify for a full contribution or $105,000-$120,000 to be eligible for a partial contribution.  For joint filers, you cannot make more than $166,000 to qualify for a full contribution.

There are also contribution limits for those who qualify.  According to the IRS,

“If you are under 50 years of age at the end of 2009: The maximum contribution that can be made to a traditional or Roth IRA is the smaller of $5,000 or the amount of your taxable compensation for 2009. This limit can be split between a traditional IRA and a Roth IRA but the combined limit is $5,000. The maximum deductible contribution to a traditional IRA and the maximum contribution to a Roth IRA may be reduced depending on your modified adjusted gross income.”

“If you are 50 years of age or older before 2010: The maximum contribution that can be made to a traditional or Roth IRA is the smaller of $6,000 or the amount of your taxable compensation for 2009.  This limit can be split between a traditional IRA and a Roth IRA but the combined limit is $6,000.  The maximum deductible contribution to a traditional IRA and the maximum contribution to a Roth IRA may be reduced depending on your modified adjusted gross income.”

Finally, you can contribute up until the tax-filing deadline in the following year.  In other words, for the 2009 tax year, you have until April 15, 2010 to make your contribution.  For those who qualify, the Roth is often the best way to supplement an employer- sponsored retirement program.  401k, 403b and similar programs are still the best place to save your money over the long-term, but a Roth IRA can be a good idea if you’ve maximized those contributions.  Don’t let the Roth IRA be a mystery any longer, and for the record, I’d go with David Lee Roth, too.

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