What is a Roth IRA?
Roth Individual Retirement Arrangements (IRAs) are special accounts
designed to help individuals save for retirement. A Roth IRA is funded with after-tax
dollars and only the earnings are taxed when distributed. A Roth
IRA is a great way to compliment a 401k or protect your assets if you think your
tax rate will be higher in the future.
About Roth IRAs
Named after Senator William Roth, Jr., Roth IRAs were first made available
in 1998. Roth IRAs are a special type of account designed to help an individual save fore retirement. Roth IRA accounts differ from other retirement accounts
in that they are funded by post-tax dollars. Like a Traditional IRA, there are annual
contribution and distribution limits. Unlike a 401k, 403b, or other employer-sponsored
retirement account, IRAs are opened and funded by the individual investor. Because
you are responsible for the account, you can choose any asset type to place in your
account. Because of this, many investors use a Roth IRA to house tax-inefficient
investments such as frequent stock trades or assets like small cap mutual funds.
Why a Roth IRA?
Roth IRA & the importance of retirement saving: In the past, pensions
and Social Security have largely assisted individuals with a means to retire. Today,
the burden of saving for retirement lies more and more on the individual, leading
more people to seek out IRAs and other tax-advantaged accounts to save for retirement.
With most Americans saving very little of their paycheck, the fate of Social Security
questionable, and large companies cutting benefits, it has never been more important
to have an individual retirement account that you control. For many people, a Roth
IRA account is an integral part of their overall
portfolio in saving for retirement.
The true power of retirement accounts, whether they are employer-sponsored or individual,
is in the ability of the funds to grow without annual taxation. The most important
factor in compound interest is that of time, so the earlier you begin saving, the
more time your account has to grow. There are dozens of examples out there to show
how saving 5 or 10 years earlier shows differences at retirement in the tens of
thousands of dollars. Roth Accounts allow you to take control of your retirement
planning by allowing you to pick the assets you want, when to contribute, and withdraw
your contributions at any time without penalty.
Roth IRA as an emergency fund: Because contributions to a Roth IRA can be
withdrawn at any time, many people use a Roth IRA as an emergency fund. As long
as there is not an emergency, you have retirement savings growing tax-free. If you
do encounter an emergency,
contributions in a Roth IRA can be withdrawn and used to pay off the expenses.
As long as the earnings are not
withdrawn, there is no tax penalty. While some think an emergency fund in
a Roth IRA is a great idea, others advise against it for a variety of reasons. For
one, mixing retirement accounts and emergency funds seems to go against the original
idea behind the Roth IRA. Others note that the Roth IRA is ideal for tax-inefficient
assets and you will probably want low-tax, safe, liquid assets in an emergency fund.
Roth IRA vs. 401k and Other Plans
A Roth IRA will ideally not be your sole retirement account.
Hopefully your company provides a 401k, 403b, or other retirement account. Since
company sponsored plans typically provide a match on employee contributions, there
is no reason to miss out on that kind of return. Every star wall-street manager
cannot come even close to the 50%, 100%, or even 150% match some companies provide
each year on a portion of your pay. However, if you reach the amount your company
matches and still want to save more, a Roth IRA provides an excellent
place to continue saving. Since contributions to a Roth IRA are
made post-tax, the dollar in your Roth IRA is worth more than the pre-taxed dollar
in your 401k. And since you control exactly what goes into your Roth IRA, you can
chose different funds, choose an annuity, or even hold Certificates of Deposit to
compliment your other retirement account. After you meet your company’s match and
then reach your annual contribution limit for the Roth IRA, you next best option
is to continue to fun your 401k, even without the match. The tax benefits of these
accounts far outweigh holding money in a taxable account for your retirement.
Other Retirement Accounts
There are many other ways to save for retirement while still receiving some sort
of tax protection. While most companies provide 401k programs, there are also Roth
401k programs that allow post-tax savings sponsored by the employer, 403b plans
for government-approved organizations, and traditional IRAs. Government savings
bonds and tax-managed index funds are excellent ways to protect yourself from taxes
in non-retirement accounts. Depending on your individual needs and income, any of
these plans can help you save for retirement.
- "Creator of Roth IRA dies." Associated Press. msnbc.com, 14 Dec. 2003. Web.
10 Feb. 2012. < http://www.msnbc.msn.com/id/3711630/ns/politics/t/creator-roth-ira-dies/
- Photo Credit: John Duricka / Associated Press < http://www.msnbc.msn.com/id/3711630/ns/politics/t/creator-roth-ira-dies/
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Page last modified 2/26/2012