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Benefits, Rules and Timing for Opening a Roth IRA

Did you know that you can still open an IRA or make contributions to your existing IRA up until the April 15th tax deadline?  Contributions may be credited to either your 2014 OR your 2015 tax year, whichever would be most beneficial to you.
Now is also a great time to consider opening a Roth IRA.  With a Roth IRA, follow a few simple rules and any money you put into one of these retirement-savings accounts grows absolutely tax-free.   You won’t owe the government a single dime as you let your savings accumulate, or even when you cash out in retirement.
Many clients ask about the benefits of opening a Roth IRA, and how the Roth differs from traditional IRAs.  Let’s examine the Roth IRA and compare it to a traditional IRA:

What IS a ROTH IRA?

A Roth IRA is basically a retirement savings tool that provides tax-free income in retirement.  Prior to retirement, taxpayers may contribute already-taxed income to a Roth IRA-up to $5500 for tax years 2014 and 2015-and then choose where to invest the money.  Roth IRAs may be invested in almost anything:  stocks, bonds, mutual funds, CD’s…even real estate!  Upon retirement, ALL of the income, both original capital AND earned interest, may be withdrawn TAX FREE!  This is in contrast to a traditional IRA where both the original investment and all earned interest are taxed upon withdrawal. Roth IRAs appeal to anyone who wants to minimize their tax bite in retirement
What is the Benefit of a Roth IRA?

Let’s imagine a scenario where a 25-year-old opens a Roth IRA and contributes $5000 per year  until retirement, with an average annual return of 8% on the investment.  Upon retirement at age 65, our smart saver will have accumulated $1.4 million dollars and ALL of that money may then be withdrawn TAX FREE!  Not a single cent will need to be paid in taxes at the time of withdrawal!
Contrast this with the same scenario but with a traditional IRA instead of a Roth.  If that same 25-year-old invested that same $5,000 a year in a traditional taxable IRA earning the same 8% return, our saver would only have about $1 million dollars at age 65  if those  earnings were taxed at 15% each year. That’s over 25%  less money compared to the Roth. Figure in state taxes and that dollar amount drops even lower!

A Few Rules, Perks and Caveats to the Roth IRA:

Of course, there are some rules that apply to the Roth IRA:    For example, only earned income from a job can be used to make Roth contributions.  You can’t contribute money that is either gifted to you or borrowed.  There are also income limits but those do go up each year and if your income breaks through the ceiling, you won’t have to liquidate your Roth, just stop making further contributions.
There are even more perks to your Roth IRA!  First, if you find yourself in a tight spot, you can withdraw your contributions at any time, tax free and without penalty. Keep in mind that you can ONLY take out your contributions at any time without penalty and tax — not your earnings. If you withdraw any of your earnings before age 59½, you’ll trigger a tax bill  plus a penalty!  On the bright side however, the way the IRS looks at things, the first money that comes out of a Roth IRA are your contributions so they are  tax and penalty free. Only after you’ve drained every penny you have contributed do you begin to dip into earnings.  Only then will you have to worry about taxes and penalties. There are even ways to avoid taxes and/or penalties, for example  if you withdraw money to buy your first home or to pay for a child’s college.

There are several other rules and exceptions that you should  discuss with your accountant prior to investment or withdrawal from any retirement fund.
If you have any questions about IRAs or which type of IRA will be most beneficial for YOU, please call or email your Hysjulien and Associates Tax Professional.

March 9th, 2015

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