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Roth IRA
Named after the late U.S. Senator William Roth, the Roth IRA was created by the Taxpayer Relief Act of 1997 and became available for use on the first day of 1998. It is a variant of the Individual Retirement Account (IRA) that had been in use since its own creation in 1974 as part of the ERISA (Employee Retirement Income Security Act) amendments to the tax code.
As opposed to the “regular” IRA, the Roth IRA allows no deductions for plan contributions, but does establish a benefit unavailable in other traditional retirement plans. By meeting certain criteria, you (or your designated beneficiary) can draw out all of the plan earnings tax-free when they’re needed.
Pros and cons
The Roth IRA also eliminates what is called the “early distribution penalty” for certain kinds of plan withdrawals, and relieves you of the requirement to take only “minimum distributions” after age 70-1?2. These are important benefits, but may or may not fit your own retirement plan, so make sure to get good advice, as always.
The primary advantage of the Roth IRA, of course, is clear. With it, you can shield your account earnings from taxation. Because this advantage comes at a known price – no deductions for contributions – the appropriateness of a Roth IRA for your specific financial plan can be calculated with a fair degree of accuracy.
How to decide
The decision to use a Roth IRA versus a “regular” one always depends on your personal financial situation, as well as on what you are assuming about your future income and future needs. Do you know long you will wait before you need to take money from your IRA? What do you think your tax bracket will be at that time? What other earnings, taxes, investment results and life/career changes will happen in the meantime to affect your decision?
Of course, you need to do your own calculation and analysis, but generally speaking, most people today are better off in the Roth IRA. The main reason is that the Roth IRA is simply bigger than the regular IRA since it contains after-tax, not untaxed, dollars. Therefore, if you can maximize your contributions you can add a great deal of “tax leverage” to your retirement income. Depending on how you answer these questions – and what a sensible financial plan indicates about your lifetime earning potential – you will soon understand whether your particular situation warrants a Roth IRA.
Other advantages
There are two other, very compelling advantages to the Roth IRA. The first is that minimum distribution rules are irrelevant, so if your other retirement resources are sufficient you are not required to take your Roth IRA distributions at age 70-1?2. What this means, of course, is that your account continues to grow, and does so in a tax-free fashion.
The second big advantage is that you are able to take specified, early distributions without paying a penalty. To summarize, then, the Roth IRA is an easier and more efficient way to keep your money in the account and working for you - and offers easier ways to take your money out, too. As always, “your mileage may vary,” but a lot of folks get farther down the retirement road, and in better overall shape, thanks to the advantages of the Roth IRA.
