Like a knife, a Roth IRA is neither inherently good nor inherently bad. In the hands of a thug, a knife can be a deadly weapon. In the hands of a skilled surgeon, a knife is a life-saving device!
Roth IRAs are a special type of individual retirement account (IRA). When “traditional” IRAs were originally made available, it was on a tax-deductible basis. You could contribute up to $3,000 and if you were not participating in another retirement plan or did not make too much money, you could deduct the $3,000 on your tax return.
For 2010 and 2011, the amounts are $5,000 for people under 50 years old and $6,000 if you are 50 or older. If you are a participant in another retirement plan, you cannot contribute to a normal IRA if you make more than $109,000 in AGI (married filing jointly), or $66,000 (single). In a Roth IRA, you cannot contribute if you make more than $177,000 in AGI (MFJ) or $120,000 (single).
Under a Roth IRA, the difference is that these contributions are NOT tax deductible. The tradeoff is that if you meet certain conditions, such as holding the account for at least five years, then the increase in value of the account (interest, dividends, and capital gains) are ALSO not taxable!
Generally, the younger you are, the better it is to start putting into a Roth. The number of years of tax-free earnings will far outweigh the benefit of a traditional IRA. Conversely, the older you are, the less advantageous the few years of tax-free earnings will be. Your income tax bracket also comes into play here. If you are going from a high income tax bracket in your earning years and into a low one in your retirement years, perhaps the deferral is not as attractive.
In 2010, there was a big frenzy to convert traditional IRAs to Roth IRAs. The government was putting this forth as a taxing measure to offset some spending. If you converted to a Roth IRA, be sure to speak with a tax advisor to get the best tax treatment on the conversion.
My biggest concern over Roth IRAs is what I like to call the “Social Security dilemma.” They TOLD us that Social Security would never be taxed, until they needed the revenue from it! I fear that the same thing will happen to Roth IRAs. That they will not allow the tax deduction up front, but will later decide that Roths were a “bad investment” and decide to tax the earnings down the road!
For all of your investment, retirement and financial questions make sure to contact a trusted and experienced financial advisor.
Reno’s Best CPA,