For those of you who have started researching retirement savings, you may have asked yourself “who is this Roth guy and what’s so great about his IRA?” Well, today we’re going to discuss the Roth IRA and Roth 401(k) so you can see what all the hubbub is about.
William Roth was a Delaware legislator who sponsored the Taxpayer Relief Act of 1997 and the Roth IRA was established as a result. In the late ‘90s, Roth was becoming concerned about the low savings rate in the United States, so he envisioned a type of individual retirement account that would attract young Americans. The idea was to give them the opportunity to invest after-tax dollars, which could lead to an added benefit of 10 to 25 percent, according to Gobind Daryani, author of Roth IRA Book: An Investor’s Guide.
How do they work?
Traditional IRAs are tax-deferred while Roth IRAs are not. So, the contributions you make to a Roth IRA account are taxed on the front end and your withdrawals at retirement are not; that is, if they are qualified distributions. Another benefit to Roth IRAs is investors don’t have to be concerned with required minimum distributions in their lifetime, opposed to traditional IRAs and 401(k)s.
For distributions to be qualified, the withdrawal must be made at least five years after the Roth IRA is established and must meet one of the following criteria: (1) the Roth IRA holder must be at least 59½ years old, (2) the withdrawal is under the amount of $10,000 and is to be used for the purchase or the rebuilding of a first home for yourself or a qualified family member, (3) the withdrawal happens after the account holder becomes disabled, or (4) the funds are distributed to the beneficiary of the Roth IRA after his or her death. The contributions that you have made to the account are always accessible, however you must meet the above criteria to withdraw your earnings.
Roth IRAs can only be established by institutions approved by the IRS. Generally, these are brokerage firms, banks, credit unions, etc. Roth 401(k)s, however, are employee sponsored. Both Roth IRAs and Roth 401(k)s are taxed upfront, however Roth 401(k)s follow many of the 401(k) rules. You should research the difference between them to figure out what works best for you.
The allure of getting taxed on the front comes from expecting your tax rate to be higher at retirement. As a young, low-wage worker with plenty of room to move on the career ladder, you can expect to save on taxes earlier on when your tax burden is significantly lower than it would be at retirement.
Limits to the Roth IRA
Roth IRAs have income eligibility limits, so depending on how much you make you may have reduced contributions or you may not be able to make contributions at all. For example, if you are single, your contributions will begin to be reduced If your income is at least $120,000 (in 2018); if you make over $135,000, then you won’t be able to contribute at all. If you’re married and file jointly, your contributions will begin to be reduced at $189,000 and you won’t be able to contribute any amount if your income is over $199,000.
The maximum you can contribute to a Roth IRA is $5,500 a year if you are under the age of 50 or $6,500 if you are over the age of 50. This compared to the 401(k) limit of $18,500. Also, if you end up having a lower tax rate at retirement, you’ll end up having paid more on taxes than you would with a tax-deferred plan.
Hopefully, this post gives you a better idea of how Roth IRAs and 401(k)s fit into the savings playbook. If you’d like to learn more about savings or financial services, follow NEXT Financial Group, Inc. on Facebook and LinkedIn and subscribe to this blog at the right-hand side of the page.
https://www.rothira.com/senator-william-roth-envisioned-roth-ira
https://en.wikipedia.org/wiki/Roth_IRA#History
https://www.investopedia.com/terms/r/rothira.asp
https://www.investopedia.com/terms/q/qualifieddistribution.asp
