When You Should Consider a Roth IRA


27 March,2012

One of the best retirement planning tools out there is the Roth IRA. However, there are people who don’t know about the Roth IRA. That’s actually too bad for them. The Roth IRA is a great tool for many who are looking for a way to increase their nest eggs, while reaping specific tax benefits.

Pay Taxes Now, Save Later

The biggest benefit to the Roth IRA is related to the tax benefits. All tax-advantaged retirement accounts have their own benefits. The Traditional IRA allows you to enjoy a tax deduction now, reducing your taxable income so that you don’t owe as much money right now. A Roth IRA is a little different. Instead of getting a deduction now, you make contributions with after-tax dollars. The upside is that you don’t pay taxes when you withdraw the money during retirement.

With the Roth IRA, you end up paying more in taxes now than you would with a Traditional IRA. There is no tax deduction for your contributions. The upside, though, is that you don’t have to pay taxes later. A Traditional IRA is merely tax-deferred. This means that when you withdraw money from your retirement account, you have to pay taxes on it — just as if it’s regular income. When you withdraw money from your Roth IRA, though, you don’t pay taxes on it. Your money grows tax-free.

This setup is ideal for those who believe that:

  • Taxes will go up in the future: Do you think that taxes will rise later on? Many people believe that the current state of affairs is unsustainable. After all, with deficits still a big reality, and few politicians and citizens prepared to really cut spending, taxes could very well go up. If taxes go up in the future, having a Roth IRA can be a big advantage, since you already paid taxes at a lower rate, and can enjoy your money without paying taxes at a higher rate.
  • Retirement will occur in a higher tax bracket: Do you think you will retire in a higher tax bracket? If you think your income will put you in a higher tax bracket, you will want to consider a Roth IRA. Pay taxes now, in your lower bracket, and avoid paying them in a higher bracket later. Of course, if you think that taxes will go up, even being in a lower bracket might not be much of an advantage later.

As you can see, the Roth IRA provides a way to help you take advantage of the power of compound interest while at the same time enjoying some tax benefits. And, even if you can’t contribute to a Roth IRA, you can still convert a Traditional IRA to a Roth later (but you do have to be careful of the tax consequences, which can be quite severe if you convert a large amount).

In the end, nearly anyone who qualifies to contribute to a Roth IRA can benefit. However, you should still carefully consider your individual situation, and consult with a financial professional, before you take the plunge.