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Falling in Love with Roth IRAs

Everyone dreams of retirement in different ways.  Some of us dream of relocating down South where the weather is warmer and the expenses are lower.  Others envision staying close to family members.  We all dream of travel and pursuit of our hobbies and passions.  For some people, their retirement dreams will be funded from their retirement savings only after paying hefty taxes to Uncle Sam.  For others, their dreams will be funded completely tax free.

Think of your retirement savings as one big cake made up of different slices such as 401(k), IRA, Roth, annuities, etc.  Each time you take a slice you will, more than likely pay taxes.  Wouldn’t it be nice if every slice of your retirement cake was available to you completely free of taxes?  Imagine not having to pay taxes on most of your income at retirement.  The question is, how can you get a bigger tax-free slice of that retirement cake?

The number one form of saving for retirement is with your employer sponsored 401k (or 403b).  The components of a 401(k) plan are employee and/or employer, and for those who max out their employee contribution, we have the option of making after-tax contributions.  You pay taxes now on your contribution and the earnings are tax-deferred.  Although the earnings and interest will be taxed when you retire, the money you contribute will be distributed to you tax-free.  There are even provisions that allow you to take your after-tax contributions at retirement and convert those to a Roth (the best slice of the cake).

The best way to capture the sweetest part of that cake would be the Roth 401(k) slice.  Instead of having your contributions pre-tax, you pay taxes now and all the earnings are available to you – free of taxes.  Roth 401(k)s are after-tax money that grows tax-free, which certainly sweetens the deal.  The best part, when you use the Roth inside of your 401(k) there are not any income restrictions.  No matter what your salary is, you can contribute 100% of your employee contributions as a Roth.

Sadly, not everyone has a 401(k) plan and not every 401(k) has made the Roth component available.  Outside of your 401(k) plan you may be eligible to make your own Roth contributions.  Eligibility is based on having earned income—salary, wages, commissions, tips, bonuses, and even income from self-employment.  Unemployment compensation, capital gains, investment income, deferred compensation, pension, life insurance proceeds, disability insurance income, child support, and Social Security does not count.

Here are the current contribution limits for Roth IRAs:

Filing Status 2020 2021 Contribution Limit
Married Filing Jointly / Qualifying Widow(er) Less than $196,000 $Less than 198,000 $6,000 ($7,000 catch-up for age 50+)
$196,000 to $205,999 $198,000 to $207,999 Begin to phase out
Single, Head of Household Less than $124,000 Less than $125,000 $6,000 ($7,000 catch-up for age 50+)
$124,000 to $138,999 $125,000 to $139,999 Begin to phase out

Another benefit of a Roth IRA account is the prospect to start early.  Young adults who have earned income can contribute.  For example, if your child had a part-time summer job and earned $2,500, they can contribute 100% of that earned income to a Roth of their own.  Starting young gives a valuable opportunity for the money to grow.

There are other ways a Roth IRA can sweeten that retirement deal.  Unlike traditional IRAs, there is no age where you are forced to take a withdrawal.  The money can continue to grow untouched past the age of 72.  New tax laws allow you to continue to contribute (subject to income limits above) as-long-as you are still working, regardless of age.  Withdrawals from your Roth can be taken without penalties or taxes as long as you are over 59½ and have owned the account for 5 years.  There are certain exceptions for under 59½ distributions.  These include using the money for a first-time home purchase, a qualified education expense, unreimbursed medical expense, or a permanent disability.

Like many things in life, it is important to have a balance between tax-deferred and tax-free portions.  It’s like having your cake and eating it, too.  There are many reasons to fall in love with a Roth IRA and it’s never too late to start.

Roberta L. Nestor is a financial advisor practicing at 759 Boston Post Road in Milford, CT offering retirement, long term care, investment, and tax planning services.  She offers securities and advisory services as a Registered Representative and Investment Adviser Representative of Commonwealth Financial Network – a member FINRA/SIPC and a Registered Investment Adviser.  Fixed insurance products offered through Nestor Financial Network are separate and unrelated to Commonwealth.  Commonwealth Financial Network or Nestor Financial Network does not provide legal or tax advice.  You should consult a legal or tax professional regarding your individual situation.  Roberta can be reached at Nestor Financial Network, 203-876-8066 or roberta@nestorfinancial.com.

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