To Roth Or Not To Roth

| Monday 9 August 2010

To Roth or not to Roth – Many people are familiar with a Roth IRA. Put money away, after taxes are paid on those earnings, let the money grow tax differed in the IRA, then take tax-free distributions of the earnings. Not a bad deal, lets go through it again. Earn $40,000. Pay taxes on all $40,000. Put $5000 into Roth IRA, after tax. $5000 grows to $75,000 over your lifetime. Take original $5000 out of taxes were paid when that money was earned. Take $70,000 tax-free. Nothing due on earnings. In a regular IRA you put $5000, before taxes, from earnings into same investments in IRA, grows to same $75,000 over time. Then pay taxes on all $75,000 when taking it out of IRA. Pay taxes now on $5,000 and nothing later, $70,000 distribution tax-free. Or, Pay no taxes now on $5000 and pay taxes on full $75,000 taxable distribution. Seems fairly straight forward, especially if you think taxes will be the same or possibly higher when you retire. Here is where it gets interesting. A Roth IRA has earnings limitations. If you earn over $120,000 as a single person, or over $177,000 as a married person, you can not make a Roth contribution. Tough luck. But wait.. Making an employee contribution into a Roth bucket in your 401(k) has no earnings limitation. You can put full employee contribution into the Roth bucket not just $5,000. If you earn $200,000, are over age 50, you can put $22,000 into the Roth 401(k) at work. In 25 years that $22,000, earning 6% grows to $94421.16. The $22,000 had taxes paid when earned, but the growth $72,421.16 is never subject to taxes. I’d call that the best kept secret out there. This is an example and anyone interested in further information should contact a registered financial advisor, or ask about a Social(k) 401(k) / 403(b) at work.
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