Should You Open a Roth IRA?

by Jason on March 22, 2010

Tax Season is upon us and this time of year usually gets people thinking about funding IRA contributions for last year, which usually leads to a question of – which type of IRA is right for me?

Today we’re going to briefly talk about Roth IRAs.  There’s been a lot of talk about Roth IRAs this year because of the new IRS rules regarding Roth Conversions.

As always, no investment is right for every single person, but in the right scenario, Roth IRAs are a great retirement savings tool.

Let’s start with the basics:

Roth IRA vs Traditional IRA

A Roth IRA is an Individual Retirement Account named after its legislative sponsor, late senator Bill Roth, that was established in 1998 to provide an alternative method of saving for retirement that offers different tax advantages than the Traditional IRA.

Under this section of the tax code, a Roth IRA is funded with after-tax contributions, which simply means you do NOT get a tax break up front.

With a Traditional IRA, provided you meet certain qualifications, which we’ll cover in a future post, you can deduct your contributions up front and get a tax break NOW.

So remember – at its very basic level, a Roth IRA gives you a tax break later

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Roth IRA Withdrawals Are Tax Free

You are funding a Roth IRA with after-tax dollars, and the money still grows tax-deferred.  You cannot deduct your contributions; however, in retirement you can withdraw your money (provided you meet certain qualifications) completely tax free.

Not only that, but as long as your Roth IRA has been in existence for five years, your beneficiaries on the account can pull out money income-tax free, so the Roth IRA becomes a nifty estate planning tool as well.

What are the qualifications to make sure your Roth withdrawals are tax free?  Here’s a great little chart from the IRS website, publication 590.

Figure 2-1. Is the Distribution from Your Roth IRA. Taxable?

Income Limits

Limits, there’s always limits!

Here’s the deal with the income limits and phase outs for your contributions:

  • If you are married filing jointly your contributions are reduced if your modified adjusted gross income (AGI) is between $167,000 and $177,000. Beyond that – sorry! No can do.
  • If you’re a single filer, your contributions are reduced if your modified adjusted gross income (AGI) is between $105,000 and $120,000.  You cannot make a Roth IRA contribution if your modified AGI is $120,000 or more.

Some Things to Consider When Opening a Roth IRA

  1. When will you need the money? Remember, this is a retirement account – so ideally you want to put in the back of your mind that this is “post 59 1/2″ money.  But, the nice thing about the Roth is that your contributions are available without tax or penalty, so if you do run into a bind you’ve got some money available.
  2. What is your tax status now? If you are in a low bracket now and are figuring that your income and therefore your tax bracket will be increasing in the future, then a Roth IRA makes a lot of sense because you’ll be pulling money out tax-free in a higher bracket giving you more advantage.  If you’re in a high bracket, remember that contributions to a Roth IRA do not reduce a taxpayer’s adjusted gross income (AGI).
  3. What will be your tax status in the future? Again, if you think that your tax bracket will be increasing, the benefit to the Roth looks even better;  if you think your bracket will be decreasing and your income will go down in retirement then you want to consider whether the Roth IRA makes the most sense for you.  It doesn’t mean you shouldn’t do it, after all – it’s smart to diversify yourself from a tax standpoint - just make sure you know what you’re getting into.

How Do I Open a Roth IRA?

You can open a Roth IRA through any financial institution, bank, life insurance or mutual fund company or even right online through a brokerage website.  Where you establish one primarily depends on your own needs and preferences.  There are many investment options available as well, so consider the types of investments that will suit your needs (i.e. stocks, funds, CDs, ETFs etc).

Contributions must be made by the time you file your tax return. So, you have until April 15 of the following year to get your Roth contributions in for the previous tax year.

The Roth IRA can be a great investment and retirement savings vehicle for many people.  Be sure to do your homework, develop a plan, assess your needs and be comfortable with your decision.

What are your thoughts?

Readers, do you think the Roth IRA is a good idea or is it a trick by Uncle Sam to get more tax revenue up front?

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{ 18 comments… read them below or add one }

Craig Ford March 22, 2010 at 7:13 am

I’m a fan of the Roth IRA and I think that it can be a great option for folks. Converting may be a good idea if you have the money to pay the taxes.
I think it might be a good idea for people to have some money in a Traditional and some in a Roth. Just in case …
.-= Craig Ford´s last blog ..Christian Workaholics | Lessons From The Sabbath Principle =-.

Kevin@OutOfYourRut March 22, 2010 at 8:11 am

What I like about the Roth is the fact that while you are making a retirement provision, the fact that the money can be withdrawn tax free gives you options in the event the money is needed more immediately.

Life isn’t as smooth as the financial media pretends it is, and we need to be ready for what ever might happen.
.-= Kevin@OutOfYourRut´s last blog ..Making Money-Goes-to-Money Work For You =-.

Jason March 22, 2010 at 9:51 am

Craig – thanks for weighing in. I’m a big fan of tax diversification – having money spread around in both Traditional and Roths is generally a good idea.

Jason March 22, 2010 at 9:52 am

Kevin – I agree, that feature makes the Roth’s very appealing for those just starting out who want to save for Retirement, but unsure of what the future holds. We do need to be ready for the unknown.

Sandy March 22, 2010 at 10:58 am

We are 64, DH retired in Jan. I retired 8yrs ago. He has a traditional IRA. Should we convert to Roth? OR is it too late. thanks.

Jason March 22, 2010 at 7:17 pm

Sandy, thanks for your question. There are a lot of variables that go into this consideration. Check out my guest post over at Wise Bread on Roth Conversions, but without knowing your overall situation it’s a tough call.

JoeTaxpayer March 22, 2010 at 11:32 pm

Sandy – the issue is pretty complex, but an understanding of where you are can help.
Your 2009 return will tell you what your taxable income is. If you use tax software, see how your tax changes by adding a $100 IRA withdrawal. If it’s by much more than you expected and you collect social security, you are in a phantom tax rate bubble and should probably not convert.
Your total pre-tax IRA balances will give you an idea of your current and future RMDs. You might want to see where you fall within your bracket and convert to “top it off.” In other words, convert enough each year to stay in that bracket but no go above.
.-= JoeTaxpayer´s last blog ..A Spring Has Sprung Roundup =-.

Jason March 23, 2010 at 8:46 am

Joe – good advice, thanks for your input!!

Sandy March 24, 2010 at 7:52 pm

Thank you for your responses. I possed my question wrong … I didn’t mean Roth conversion.

As I said we are both retired now which means when we file our 2010 taxes we will be down $60K. We do not own Roth IRA’s and never have, only a traditional IRA. My real question is does it make sense to open Roth IRA’s now at age 64 taking into consideration our income will be down $60K (2010).

By open Roth IRA’s now for 2009 it will cost us a $3700 federal refund and to pay $1K to the State. This is why I don’t think opening Roth’s makes sense. OR am I totally in left field.

Hope all this makes sense.

Jason March 24, 2010 at 8:20 pm

Hey Sandy, if you don’t have earned income you cannot contribute to the Roth anyways – so it may be a moot point. Again, without knowing more and taking a full inventory of your situation it’s tough to say if you did have earned income. Roths can also be a good estate planning tool since the proceeds are tax free to the beneficiaries – something else to consider.

sc June 21, 2010 at 1:01 pm

Subject to the usual qualifications, is it possible to open a Roth IRA up to the maximum, every year, say for the next ten years?

Any thoughts will be appreciated.

Jason June 29, 2010 at 8:07 pm

SC – Yes, it is possible to open a Roth IRA every year. But to clarify – you don’t need to open a new Roth every year (if that’s what you are asking). You can contribute to the same Roth each year up to the max provided you fall under the income limits.

Vickiopenarothira September 2, 2010 at 6:14 pm

Should I open a roth ira…question is taxes now or later!

Larry January 27, 2012 at 1:37 pm

I’m 60 and my Roth IRA has lost $ over the years. Can I cash in what’s left and use the loss to offset my income on my taxes? Can I carry over losses in excess of $3000 to the following years?

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Darrell May 15, 2013 at 11:29 pm

I have a traditional IRA,and would like to withdraw some money to reroof my first/
current home. Does this withdrawal purpose avoid the 10 percent early withdrawal penalty? I am age 51

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