Perhaps some of you struggled through World Literature like I did in school.
Frankly, the problem wasn’t my teachers. A lot of it had to do with me and where my mind was at that stage of life. In particular, I remember trudging through Shakespeare’s Hamlet and reciting the well known pronouncement “To be or not to be, that is the question.”
This month, I’ll put the liberal arts education — my parents paid — to good use and discuss the pros and cons of funding your retirement account through a Roth IRA.
Since the introduction of IRAs back in 1974, along with the rise of 401(k) programs in the 1980’s, there has always been the presumption that most working individuals will end up in a lower tax bracket after retirement. But, it is not altogether wise to assume that will occur. In fact, it could be just the opposite. And, if you throw into that mix the possibility of higher taxes down the road to pay for federal budget deficits along with Obamacare and the like, our income tax burden in the future could be higher than ever.
A great addition to the retirement tool chest for individual working Americans and one that is often misunderstood is the Roth IRA — named for the former U.S. senator, the late William V. Roth, Jr., of Delaware. The Roth IRA came into being on Jan. 1, 1998, and is growing more popular every year.
In many ways — especially as it pertains to contributions, it looks similar to a regular IRA. Contributions for 2014 (and 2013 if you’ve not filed your income taxes) are available up to $5,500 this year. If you’re 50 or older, by the end of this year, you can add another $1,000.
You can make contributions to a Roth plan if you participate in a company sponsored retirement plan such as a 401(k), but there are certain conditions.
First, and quite obvious, you or your spouse must have compensation or alimony income equal to the amount you wish to contribute.
Second, you are limited to making a contribution on the basis of your modified adjusted gross income which can’t exceed certain limits. For the maximum contribution in 2014, according to the IRS website, the limits are $114,000 for single individuals and $181,000 for married individuals filing joint returns. The amount you can contribute reduces gradually and then is completely eliminated when modified AGI exceeds $129,000 single or $191,000 married filing jointly. As to your own specific situation, be sure to check with your accountant or financial adviser.
Here’s where a Roth differs from a regular IRA. The Roth IRA provides no income tax deduction for your retirement contribution, but instead, provides a benefit that isn’t available for any other form of retirement savings. That is — if you meet certain requirements — all earnings are tax free when you or your beneficiary withdraws them. Other benefits include avoiding the early distribution penalty in the event of certain withdrawals. That’s a key point to the Roth; with a regular IRA, if you withdraw any cash out of your retirement account before age 59½, you’ll pay a 10 percent federal tax penalty plus the entire amount withdrawn is taxable in the year of receipt at your current level of income taxation.
Another key benefit to Roth plans allows you to bypass the requirement for minimum distributions by age 70½, plus, in the event of death, proceeds can pass to your beneficiary more favorably — tax wise.
The chief advantage of Roth IRAs is obvious; the ability to have investment earnings completely escape taxation. This comes at a price, however. You don’t get a deduction when you contribute to a Roth. But, when you add the additional features mentioned above, it makes a compelling case that the Roth is attractive to keep your money in, and also easier to take out as well.
So, which is more important? It strongly depends on your personal situation, and also on what assumptions you want to make concerning your future. How long before you withdraw this money? What will your tax bracket be at retirement? Can you commit to a payment program for 20-30 years? In addition, are you self employed? If so, does the benefit of deducting contributions help ease the pain of paying full social security /Medicare taxes at a 15.3% clip. Like everything else, the answers are not always clear.
Whatever IRA you decide — the most important thing is you do something now. For with increasing life expectancies, an uncertain future Social Security system and employers increasingly terminating pension programs, it becomes more important than ever you plan for your own retirement wellbeing. Like my grandfather Chuck used to say, the worse thing in the world is to be old . . . and have nothing.
Always remember as it relates to the financial game of retirement: Time is money.
» Ike S. Trotter, CLU, ChFC is a credential Financial Advisor in Greenville. Securities and Investment Advisory Services provided through Woodbury Financial Services, Inc., Member: FINRA, SIPC and Registered Investment Advisor, P.O. Box 64284, St. Paul, MN 55164. Tel: 800.800-2638. Ike Trotter Agency, LLC and Woodbury Financial Services, Inc. are not affiliated entities.
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