Roth IRAs For The Retirement-Savvy Investor
A secure retirement is up to you... unless, of course, you believe ketchup is the spice of life.
Anyone counting on Social Security for a secure retirement should develop a taste for dog food and ketchup.
That raises a basic question: What's the best way to avoid shaking the ketchup bottle?
Good answers are found in Roth and Traditional Individual Retirement Accounts. Each comes with advantages and disadvantages, but give the Roth IRA a close look because its long-term tax advantages are hard to beat.
"A Roth IRA is funded with after-tax dollars," says Quint Tatro, a Minyanville professor and founder and president of Tatro Capital. "Growth and qualified withdrawals are tax-free. Retirees have often accumulated all their resources in a 401(k) and when needed for retirement, the money is 100% taxable as ordinary income. This can push them into a higher tax bracket. With a Roth IRA, qualified distributions aren't taxable."
But a Roth IRA's advantages come with a price: Contributions aren't tax deductible. However, this is a minor disadvantage for many and offset by a Roth IRA's tax-deferred growth and tax-free distributions at retirement.
With a Traditional IRA, contributions may be deductible depending on your income, filing status and coverage by an employee-sponsored retirement plan. Earnings in a Traditional IRA grow tax-deferred until withdrawn in retirement. That may be a huge sticking point because who knows what the tax rate on Traditional IRA withdrawals will be in the future?
There's no penalty for early withdrawal from a Roth IRA after age 59½ if the account has been open for at least five years. However, if you withdraw earnings prior to age 59½ or if the account hasn't been open for five years, you'll be hit with a 10% penalty. After age 59½ and if the five-year holding period has been met, the penalty is waived on the following withdrawals:
- College expenses for you or a family member.
- First-time home buying expenses up to $10,000.
- Some medical expenses and payments on health insurance premiums if you're unemployed and un-reimbursed expenses greater than 7.5% of your adjusted gross income.
- Death or disability of the account's owner.
"There are many retirement plans," Tatro says. "Many people don't understand their choices or are intimidated by their complex nature. With a little homework, you may be able to save thousands of dollars."
A Roth IRA eliminates the need to take minimum distribution after age 70½ and allows your retirement savings to grow if you can draw on other retirement funds and don't need the Roth IRA money right away.
For many, this is the clincher for a Roth IRA: Money passed on to your children isn't taxed.
Individuals with an annual adjusted income of less than $114,000 are eligible to contribute to a Roth IRA. For joint filers, the limit is $166,000. Contributions to a Roth IRA may be made in addition to an investment in a 401(k) plan, a Traditional IRA or other retirement plans.
Investment options for a Roth IRA typically include mutual funds, stocks, bonds, options and Exchange Traded Funds, or ETFs. (See: "ETFs Explained") Check with your provider. Remember, these investment choices aren't insured by the Federal Deposit Insurance Corporation.
Many providers have eliminated brokerage fees on a Roth IRA, but a few may still slap you with a charge of about $25 to $50 per year per fund. The sector is highly competitive so shop around. If you switch providers, be sure to ask about startup and termination fees.
When researching IRAs, start with major banks such as J.P. Morgan Chase (JPM), Bank of America (BAC), Wachovia (WB), Citigroup (C) and Wells Fargo (WFC). The Web sites of major brokerage houses, including Merrill Lynch (MER) and Morgan Stanley (MS), also provide solid information on retirement planning. Top mutual funds, including Fidelity, T. Rowe Price (TROW) and Vanguard, also offer valuable insights on retirement planning.
Retirement is just one aspect of your financial planning. If you haven't got a budget, think about developing a spending plan. (See: "How To Make A Household Budget That Works") Don't overlook the basics, including savings. (See: "Seven Tips for Saving" and "CDARS: Seeing The Forest For The Trees") A complete financial plan will free you from the pressure of daily expenses and give you the freedom to follow your life-long interests in retirement.
The Roth IRA is named for William V. Roth, Jr. a Delaware Republican who served in the Senate from 1971 to 2001. He backed the Taxpayer Relief Act of 1997 which created the retirement savings plan. Roth said the law was designed to encourage retirement investment by all Americans, not just wealthy individuals. Roth died in 2003 at 82.
Many financial planners say you should plan to have about 85% of your pre-retirement income when you call it a career. An employer-sponsored plan may not be sufficient and there's no way Social Security alone will come anywhere close to meeting your needs.
That means a secure retirement is up to you – unless, of course, you believe ketchup is the spice of life.
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