For young workers that are likely to benefit from decades of tax-free growth, Roth IRAs can make a lot of sense. For one thing, they’ll create non-taxable income in retirement.
Roth IRAs give you the option to pay your taxes now vs. later, depending on when you think they’ll be lower. Where a traditional IRA gives you your tax break up front, a Roth IRA is funded by after-tax dollars which allows your money to grow tax-free. When you withdraw at retirement, you pay no taxes.
As they get closer to retirement, more people are converting their traditional IRAs to Roth IRAs to avoid paying higher taxes during retirement. With the likelihood of tax rates increasing in the future, a Roth IRA can save on taxes and give you more flexibility with your money. But you have to play by the rules.
- Money contributed to a Roth IRA must be earned, not gifted.
- Contributions are capped annually and subject to income limits.
If you already exceed the income limits, you aren’t eligible for a Roth. In 2014 you could contribute $5,500 if your income was below $114,000 (single) or $181,000 (married filing jointly). If your income eventually exceeds the limit, you will no longer be able to contribute to your Roth.
Obviously, if you qualify, the longer you allow your money to grow tax free in a Roth IRA, the greater the pay-off at retirement as the tax rate grows. For those who are now in their twenties, and making under $100,000, a Roth IRA is a good choice. Even down the road when your income exceeds the limit, your portfolio will be diverse thanks to both taxable and tax-free investments.