Roth IRAs are a great investment vehicle for retirement for those who qualify to contribute to them (there are earned income phase-out ranges and limitations), and they have some interesting features that can make them very advantageous.

Here are some of the advantages of a Roth IRA:

  • Anyone can contribute, as long as they have earned income; however, you cannot contribute more money than what you have in yearly earned income (ex:  if you only made $4,000 for a year, you can ONLY contribute up to $4,000 for that particular year)
  • For 2013 and 2014 the annual contribution limit is $5,500 ($6,500 if you’re over age 50), and you have the freedom to invest in any type of investment you are comfortable with (stocks, mutual funds, ETFs, bonds, CDs, annuities, etc.)
  • Your money grows TAX-FREE (however, contributions are NOT tax-deductible) so no matter what your tax bracket is in retirement (past age 59 ½), your distributions will be free from taxation
  • You have until April 15th of the following year to make a yearly contribution (ex:  you have until April 15th, 2014 to contribute to your Roth IRA for 2013), allowing 15 ½ months to fill your Roth IRA up each year
  • Rules allow you to withdraw your contributions out at any time without penalty or tax implications (NOTE:  this applies only to contributions, NOT earnings – those earnings would be taxed and then penalized 10% for early withdrawal if you are under age 59 ½)
  • Even though they are used primarily for retirement savings, you can tap into it to help pay for higher education costs without the 10% early withdrawal penalty affecting your earnings (NOTE:  you will still have to pay taxes on the earnings, but contributions are free from penalty or taxes)
  • You can withdraw up to $10,000 tax- and penalty-free if you apply that $ amount towards your first home purchase (NOTE:  it must be established for at least five years for this rule to apply; otherwise you have to pay taxes on the earnings, but NOT the 10% early-withdrawal penalty), so couples can withdraw up to $20,000 towards their first home
  • Even if you can’t contribute due to the earned income limitations, there are no longer any limits on who can convert a traditional IRA to a Roth IRA (also known as a “backdoor Roth IRA”)
  • You never need to take money out if you don’t need to (unlike a traditional IRA where at age 70 ½ you must take start taking annual RMDs (required minimum distributions)
  • You can also contribute even if you are past age 70 ½ as long as you still have earned income (you cannot contribute to a traditional IRA once you reach age 70 ½)
  • You can pass it onto your heirs without any taxes or penalties, making it a very effective estate planning tool

There are also some possible disadvantages with Roth IRAs though:

  • You do not get a tax deduction for your contributions (however, you do get to withdraw your money out TAX-FREE at age 59 ½)
  • If you’re single or filing for taxes as head of household and your AGI (adjusted gross income) exceeds $127,000 for 2013 ($129,000 for 2014) you cannot contribute.  Likewise, if you are married filing taxes jointly and your AGI for 2013 exceeds $188,000 ($191,000 for 2014) you cannot contribute.
  • If you’re single or filing for taxes as head of household and your AGI is between $112,000 and $127,000 for 2013 (between $114,000 and $129,000 for 2014) your contributions will be phased out (can’t contribute the full amount).  Likewise, if you are married filing taxes jointly and your AGI for 2013 is between $178,000 and $188,000 (between $181,000 and $191,000 for 2014) your contributions will be phased out
  • There are certain types of investments you cannot make in a Roth IRA, such as life insurance contracts, antiques, collectibles, and most precious metal coins (there are a few types of coins that are exceptions to this rule)
  • There is NO guarantee that the IRS and/or the U.S. government will never change the tax status earnings in the future (possibility of being taxed could always happen)
  • You need to have a crystal ball to determine whether tax rates will be higher, lower, or the same as in the future when you retire, which will determine the true effectiveness of Roth IRA compounding investments vs. pre-tax compounding investments over time (read this last point as “it isn’t easy to figure this out”)

Find a experienced financial advisor who deals with Roth IRAs on a regular basis, works for an RIA firm, earns his/her money from fees (NOT commissions), believes in having an abundance of investment choices for clients, and has the heart & demeanor of a teacher, NOT a salesman, and chances are you’ve found the right financial advisor to help you prepare and plan for retirement.

To learn more about Martin Federici view his Paladin Registry profile.