by Stacy Francis, CFP®, CDFA
I met with a new client last week; a woman in her early thirties eager to get started on her nest egg. A discussion of her financial goals and priorities revealed that she hoped the not-so-distant future would bring her not only a home of her own, but a few children as well. When I recommended a Roth IRA, she was all frowns. What's the point? she wondered.
This is such a common question; it deserves a blog of its own. After all, why would you make your contributions on an after-tax basis, when you could just as easily open a traditional IRA and cash in on your tax breaks right away? In this day and age, what could possibly beat the magic of instant gratification?
- With a traditional IRA, the withdrawals you make in your golden years are taxable, at your current rate. With a Roth IRA, once you’ve made your contributions, you never pay tax on the capital again (provided, of course, that you play by the rules). Since the amount you'll withdraw from the account will be much larger than the amount you put into the Roth, in most cases, your total tax bill will be considerably smaller with a Roth IRA. Remember? You don't retire off the money you set aside - but off the money you make off the money you set aside.
- If, like my client, you are aching to buy a home and start a family, note that you can withdraw money from a Roth IRA without becoming subject to the penalty tax, to pay for a first home or college tuition for yourself, your spouse or your children. No such exceptions apply for traditional IRAs.
- A Roth IRA is typically more beneficial for your heirs, should you kick the bucket.
Note, however, that there are strict income limits for contributions to Roth IRAs. Singles needs to make between $5,000 and $101,000 per year (phase-out between $101,000 and $116,000), while married couples must have an annual income of less than $159,000 (phase-out between $159,000 and $169,000). As long as you fulfill this requirement, chances are, a Roth IRA is a great option for you.
Recommended Reading: Jump-Start Your IRA!