Tax-Free Growth: Why So Many Love the Roth IRA

by Miranda Marquit · 13 comments

Those of us steeped in the personal finance blogosphere find it incredible to think that there are those who have no knowledge of the Roth IRA. However, it is true that at one time I had no idea what the Roth IRA was — and I was probably about the same age as the college seniors who surprised Jeff Rose not too long ago, providing the inspiration for a Roth IRA movement.

Luckily, my research into finances and my time as a freelance writer allowed me to learn about the Roth IRA, which will give a huge boost to my retirement.

Tax-Free Growth with the Roth IRA

One of the reasons that the Roth IRA is such a great retirement savings tool is that your money grows tax-free. When you contribute money to your Roth IRA, it goes into investments of your choosing, and you aren’t taxed on your earnings. When you withdraw money from your Roth IRA later on, during retirement, you don’t have to pay taxes on the withdrawals. This is what appeals to many.

Of course, this tax-free growth later comes with a price now. Contributions to the Roth IRA are made with after-tax dollars. This means that you don’t get a tax deduction for the money you put in. You pay your taxes now, rather than later.

The Traditional IRA is tax-deferred, meaning that you pay taxes later. You get a tax deduction now, for your contributions, saving you money immediately. However, later, when you withdraw the money from your retirement account, you have to pay taxes on the amount you withdraw — as if it’s regular income. If tax rates go up in the future, or if you retire in a higher tax bracket, you end up paying more.

One of the reasons that many like the Roth IRA is due to the fact that there is a good chance that you can pay lower taxes now, and avoid higher taxes later. Since the money in the Roth IRA grows tax free, you pay taxes at your current tax rate. That means, of course, that if taxes increase between now and your retirement, or if you retire in a higher tax bracket, that you won’t have to worry about paying taxes at that higher rate — you’ll already have paid them at a lower rate.

Downside to the Roth IRA

The biggest downside to the Roth IRA is that the contribution limits are so low: You can only contribute up to $5,000 this year. There is a catch-up contribution of $1,000 allowed for those 50 and older, but the fact remains that you can contribute far less to a Roth IRA than you can to a 401(k). (If you have a spouse who doesn’t work, you can use a spousal Roth IRA to help improve your household’s overall ability to contribute to your retirement.)

And, with the Roth IRA, there are also income limits. Your ability to contribute to a Roth IRA begins to phase out when your AGI reaches $173,000, and disappears altogether at $183,000.

Even with these drawbacks though, a Roth IRA can still be a great retirement tool — especially if you start early and contribute as much as you possible can.

Do you have a Roth IRA? Do you contribute the maximum?

Money Saving Tip: An incredibly effective way to save more is to reduce your monthly Internet and TV costs. Click here for the current AT&T DSL and U-VERSE promotion codes and promos and see if you can save more money every month from now on.
Special Offer: Trade free for 60 Days and Get Up to $600!

Related Posts

{ 13 comments… read them below or add one }

Roger Wohlner March 27, 2012 at 5:24 am

The Roth IRA is a great tool for some investors. The best thing to me about the Roth IRA is that it provides a choice for IRA investors vs. the traditional IRA. In all cases investors should take a look at their own unique situation before deciding whether a Roth is the right choice for their retirment savings needs.

One additional note, many companies now offer the Roth feature as part of their 401(k) plan. For those investors who have this option available to them the Roth 401(k) offers higher contribution limits than a Roth IRA and there are no income limits for contributing,

Reply

Jonathan@Friends and Money March 27, 2012 at 6:22 am

I’ve read a lot about ROTH IRA’s but this is one of the best articles i’ve seen for succiently outlining the benefits of it. The tax free elements sounds attractive, although I appreciate there are many better options if you are willing to increase your risk exposure.

Reply

Financial Advice for Young Professionals March 27, 2012 at 3:46 pm

Like what??

Reply

Steve the ROTH man April 25, 2012 at 1:00 pm

Better options than a ROTH? Jonathan my friend, im afraid you are mistaken. You can be as risky as you want in a ROTH. Nothing is better than a ROTH! Tax free money!!!

Reply

Steve March 27, 2012 at 7:30 am

The Roth is great for younger workers because even though the annual limits are low, over time it will add up to a lot if you invest in equities (stocks).

Reply

Mark March 27, 2012 at 8:28 am

I think it’s important to note that the income figures posted are the AGI for those married filing jointly. For singles, the contribution limit starts to phase out at AGI of $110k and disappears at $125k.

Reply

Mike W March 27, 2012 at 8:40 am

Can you contribute to both IRAs in the same year.

Reply

Mark March 27, 2012 at 9:00 am

@Mike W: Yes you can, but your total contribution limit between the two accounts can only be up to $5,000 ($6k if you’re 50+).

Reply

Mike March 27, 2012 at 11:15 am

This article is misleading. Since when is the income limit $173k! It’s only something like $105k which is far too low to be useful to many young professionals out there.

There are also some further advantages or disadvantages that should be pointed out. The good:
- The Roth IRA does not require forced distributions at age 70 1/2 like the traditional IRA does. This can be a HUGE benefit actually.
- The Roth IRA and traditional IRA both only allow contributions of $5k a year. But the Roth IRA is after-tax money which in effect means you can contribute much MORE to it that you can a traditional IRA (by, maybe 30% if that is your tax rate). This difference can add up in the long run.

The bad:
- There is no guarantee that the laws won’t change and Roth withdrawals could be taxed in the future. If you say this can’t happen, remember that Social Security income used to not be taxed and now is. If that happens the traditional IRA is better as your gonna have to pay taxes on it anyways.
- The really low income limits as I mentioned above. There is no income limit on the traditional IRA!
- You need to set up a separate account for a Roth IRA. If you’ve had a 401k and rolled it over into an IRA, you already have a traditional IRA account. You’ll need to make a separate account for a Roth IRA.

The Roth IRA should really be compared to the 401k as that is only available if your company has a plan and they don’t seem to be as common as they should be these days. Both the Roth IRA and traditional IRA can be set up all by yourself without needed your company’s support.

Reply

Financial Advice for Young Professionals March 27, 2012 at 3:47 pm

Roth IRA’s are awesome! If you have Roth IRA’s I think you should be a little more agressive and put your higher earning funds here. That way, if the market goes up, you can pull out your earnings tax free. If not, you wait and hold onto the funds until you retire and pull it out then…

Reply

virginia March 29, 2012 at 8:02 am

I see nowhere mentioned the fact that although your contributions can be withdrawn tax free; any earnings of interest will be taxable.

Reply

AJ March 29, 2012 at 7:16 pm

Virginia,

Qualified Roth IRA distributions including interest, dividends and capital gains are all tax free.

http://www.irs.gov/pub/irs-pdf/p17.pdf Page 59 top of middle column and page 134, top of middle column explains qualified distribution clear as mud. But basically, if you are over 59 1/2 and the contribution is over 5 years old, the entire distribution is tax free.

Reply

Josie August 29, 2013 at 8:24 am

This is my goal for next year after completing at least 3 month of my emergency fund. I want to max out my contribution there..I hope I can

Reply

Leave a Comment