Saving for Retirement: The Roth

Hello my budgeting friends!

Sorry I have been so MIA for the past few weeks.  Busy season is finally coming to a close, and I will give this blog a little bit more lovin’.  I’m continuing my posts on retirement accounts. Here we go!

The Roth: Another popular retirement account that could be of interest to you!  The greatest advantage to the Roth is that the money comes out tax free -- you put in after-tax money, let it build, and you take out all the money without paying the government a dime of it. It’s a great retirement account to have if you believe your tax rates will be high in 40 years when you retire, which is why it’s popular amongst younger people (will explain this more below). You can open up a Roth with pretty much any bank, and the amount you can contribute to the Roth varies a little bit each year.  For 2014, the limit is $5,500/year. 

Pros: As I’ve mentioned, the huge advantage of a Roth is that your money comes out tax-free when you retire, which is not allowed with a 401K. So think about it. We’re young and we’re not making big money just yet, so our tax bracket is at the lower end.  Then, imagine yourself 40 years from now.  We’ll hopefully be making big money and that would put us into a higher tax bracket. If you put money aside now in a Roth, you’ll be paying very little in taxes and when you finally pull the money out in 40 years, you won’t have to pay any taxes on it! 

Cons: Because you pay taxes before you put the money in, you will be building less.  So, for example, instead of putting $100 pretax, letting it build up, and paying the tax on it when you retire, you are paying tax on the $100 first which will really be like putting in $70, letting it build, and then pulling it out tax-free.  Building up $100 over 40 years will get you more money than building up $70 over 40 years.  Another disadvantage of this account is that there are income eligibility requirements (another reason why it’s popular for younger folks). If you are making more than $114K a year, the contribution limits will start to phase out.  And while I don’t know any 23 years olds making this kind of money, if you make over $129K, you won’t be able to contribute to a Roth at all.  Some people who know that they will be making this amount in a few years don’t even bother creating a Roth because they know they will be phased out eventually.  Like the 401K, you cannot pull any money out of the Roth until you are at least 59 1/2 and have held the account for at least 5 years or you will incur penalty fees.  There are, of course, exceptions to this rule. 

If you're interested in starting an account, there's a great website I found that will be able to answer more of your questions if you have any.  Still trying to figure out how to create an anonymous question box.  Closest thing I got was a poll (see left).

Next up the IRA!

Ali