3/26/2014 5:45 PM ET|
Generation Roth: How millennials can retire tax-free
Roth IRAs offer two huge advantages to young savers: lots of flexibility and tax-free withdrawals in retirement.
During a recent visit to a Pennsylvania steel plant, President Obama touted the flexibility that his new myRA account provides young workers just starting to save. "In an emergency you can withdraw contributions without paying a penalty. So it's a pretty good deal."
Fact is, myRA is just a Roth individual retirement account with training wheels; the full, grown-up version is an ideal savings vehicle for millennials, including well-paid ones who also have a 401k.
A Roth IRA has two main advantages for younger folks. Money you contribute to an old-fashioned, pretax IRA or 401k isn't taxed now, but all withdrawals in retirement are taxed at high ordinary income rates. Roth IRAs work in reverse: You get no tax deduction for your contribution, but withdrawals after age 59 are tax free.
By then your income should be higher, in real dollars, than at, say, 25, so your tax rate is likely to be higher, too, making the back-end tax break more valuable than the front-end one. A Roth could also shield you from a growing list of tax and benefit penalties on higher income retirees.
The second big selling point for a Roth IRA is flexibility. Retirement is decades away and you might need cash sooner -- to start a business, pay the rent while you return to school or, as Obama suggested, for an emergency. Take money out of a pretax IRA or 401k before retirement and you can get hit with a 10 percent early withdrawal penalty, as well as ordinary income taxes. (There are ways you might be able to avoid the penalty, but an estimated 5.7 million folks still got stuck paying it in 2011.)
By contrast, you can withdraw your original contributions from a Roth IRA without taxes, penalty or jumping through hoops. "Life is unpredictable," says Dan Keady, a financial planner in TIAA-CREF's advice strategy group. "The idea of having that money there in a Roth IRA that you can just pull is a big advantage for people."
Wait a minute, isn't a 401k the best place to start saving? Yes, usually, provided you're offered an employer match -- in the most common matches, your employer kicks in 50 cents or $1 for each $1 you save, up to maybe 6 percent of your salary.
But if you're planning a decent retirement and saving for other goals, too, you'll need to sock away a lot more than 6 percent a year. So put enough into your 401k to snag the full match and then fund a Roth IRA.
For 2014 you can contribute $5,500 per person to a Roth IRA, provided your adjusted gross income isn't more than $114,000 for a single or $181,000 for a couple. Above that, the allowed Roth contribution shrinks and then disappears.
Not to worry: If you earn too much, you can get around the restriction with a little fancy footwork (and paperwork). Put $5,500 in a nondeductible IRA and then convert it to a Roth IRA.
Fortunately, you have until Apr. 15 to fund an IRA for calendar 2013. If you don't have the cash but expect to soon -- say you've just started a high-paying job -- hit your parents up for a short-term loan to make the contribution. Another option: If you file your 1040 early enough, you can ask the Internal Revenue Service to deposit your refund into a 2013 IRA.
What if you are already snagging the match in your 401k and fully funding a Roth IRA, and can save still more? Build an emergency account (three to six months of expenses) outside the Roth IRA, so you can leave the Roth untouched, growing tax free.
Once you have an emergency cache, consider maxing out your 401k -- you can contribute up to $17,500 for 2014. Keep in mind, however, that your pre-retirement access to 401k funds is limited, particularly if you stay with the same employer.
A growing number of 401k plans give workers the option of directing some or all of their contributions into a Roth 401k subaccount. If yours does, consider using it, particularly if you expect your income and tax rate to rise. By law all employer contributions are made pretax, so by using the Roth you're spreading your tax bets.
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Oh wait thats what would be written if you replaced milennial with the rich
When you really look at the way our tax code works, virtually everyone would be best served by using traditional IRAs and 401ks vs Roth's. Every year, your personal exemption and a standard deduction make the first $10k of annual income tax free. The next $9k is only taxed at 10%, and the following $28k only taxed at 15%. That makes the effective tax rate on your first $47k of pretax income less than 10%. Yet articles like this tell people in the 15% and 25% tax brackets that Roth's are no-brainers... They're not.
The other selling point of traditional IRAs and 401ks is that in some states neither withdrawals or contributions to such accounts are subjected to state income tax, whereas you would have already paid state income tax on any money put in a Roth
Don't forget that Bill Clinton changed the Social Security rules so that if your still working after 66 your SS Income is Taxable, this is the Democrat's using both "Double Taxation" and Taxation without Representation. I know I am 67 and am still working and every quarter I am required by Fed. Tax rules to send the US Treasury over $ 570.00 dollars. Per Bill Clinton it was to help pay-off the National ( Federal ) Debt. What Joke, give a Democrat a Dollar and they will spend Millions ( Today Trillions) more. Just look at our Country's Debts, the US by basic accounting rules is already Bankrupt.
A Roth IRA Success Story
Back in 2010 I converted my Rollover IRA to a Roth using the special one-time IRS allowance to split the income recognition over 2 years. Since then, my Roth IRA has increased 43%. That translates into about 13% of my present Roth IRA which I own tax free that would have otherwise been a liability to the IRS (had I left the funds in my tax-infested Rollover IRA).
Now all I have to do for retirement is find a safe investment for my Roth that meets or beats inflation.
Oh well, nothing’s perfect.
Of course it will, Sunny,
But NO ONE wants to talk about that. They keep believing these IDIOTIC politicians, because they ONLY HEAR WHAT THEY WANT TO HEAR!!!
Wake up people! Politicians are ONLY OUT FOR THEMSELVES, AND FOR THE COPORATIONS AND PEOPLE that contribute to their reelection campaigns!!!! The REST of us poor voters can go to hell and ONLY come out to VOTE, as far as they're concerned.
If these LYING politicians REALLY gave a crap about us, do you REALLY think this country and the rest of the world would be in the crappy shape it's in now?
So, I'm sitting next to a millennial at my local pub. He is a part time contract worker for a local government site. May or may not be there after 6 months time. He's divorced with one child.
He had one mixed drink. Paid for the $3.50 beverage with a credit card, tipped $2.00 and went home. He still lives with mom & dad.
Roth, 401K, and savings at all ever? Nice try feckless Obama. Ain't gonna work unless you unleash businesses to take care of these kids cause they sure can't plan for themselves.
Oh, but that's right, the government will take care of them. Where is my baby boomer head?
First rule in tax planning....take the deduction NOW while it still exists. Tax law can change.
Fund a 401K first, then fund a Roth (but fund the Roth A LITTLE right away to start the 5 year waiting period).
“You get no tax deduction for your contribution, but withdrawals after age 59 are tax free. By then your income should be higher, in real dollars, than at, say, 25, so your tax rate is likely to be higher, too, making the back-end tax break more valuable than the front-end one.”
While it is true that your tax bracket will most likely be higher, thus giving you a better tax break come retirement, I think the real question is this:
“Is that tax savings greater than the lost revenue that would have been generated by the extra tax deferred funds you didn’t pay in at the time of deposit in the 401K?” I have a hunch the answer to that is "No", and you are probably still better off saving more heavily in a tax deferred account.
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