Young people and workers in low tax brackets have a lot to gain by saving for retirement in a Roth IRA. But this year, for the first time, high-income retirement savers also have access to Roth IRA accounts. And in 2010 only, investors can delay the taxes due for retirement account balances that are converted to a Roth. Here are more reasons you should consider contributing to a Roth account.
Lock in today's low tax rates. Traditional IRAs and 401(k)s give you a tax break during the years that you save for retirement, but you have to pay taxes upon withdrawal. With Roth IRAs and Roth 401(k)s, on the other hand, you pay the taxes upfront, and distributions that are made after age 59½ from accounts that are at least five years old are tax-free. To decide whether a traditional or Roth IRA is better for you, compare your current tax rate to what you estimate you tax rate will be in retirement. Those who expect to be in a higher tax bracket in retirement have the most to gain by paying taxes up front using a Roth account. "Young people should go for a Roth IRA and allow it to grow for 30 or 40 years," says IRA expert Ed Slott, founder of irahelp.com and author of Stay Rich for Life!: Growing & Protecting Your Money in Turbulent Times. "Generally, they are in a lower tax bracket than they will be later on and the upfront tax deduction of a traditional IRA is not worth as much because they are not earning as much." Roth accounts may not be as good of a deal for retirement savers who are currently in their peak earnings years and need the tax break now. If your taxes are currently higher than you think they will be in retirement, consider delaying taxation this year by choosing a traditional IRA or 401(k). Investing your retirement savings in both pre- and post-tax retirement accounts allows you to hedge your bets against future tax increases.
Greater flexibility in retirement. After age 70½, traditional IRA and 401(k) account owners are required to take distributions from their retirement accounts and pay the resulting income tax each year. The penalty for failing to withdraw the correct amount is 50 percent of the amount that should have been withdrawn in addition to regular income tax. Roth IRA and 401(k) owners are not required to take annual distributions, which gives them more flexibility to time withdrawals or pass on tax-free money to their heirs.
Easier access to your money before retirement. Roth IRAs give you more flexibility to make withdrawals before you reach retirement. Roth IRA withdrawals before age 59½ result in a 10 percent early withdrawal penalty and regular income tax due only on the portion of the withdrawal that comes from earnings. Like traditional IRAs, penalty-free early withdrawals are also allowed for several reasons, including college costs, health insurance premiums after losing your job, significant unreimbursed medical costs, and certain first-time homeownership costs.
More money for heirs. Beneficiaries must pay taxes on the money they withdraw from traditional 401(k)s and IRAs. But your children and grandchildren may be able to receive tax-free distributions of the money you leave them in a Roth 401(k) or IRA. "If you are never going to need this money, it makes sense to consider a Roth and let the assets grow until your children's generation," says Beth Gamel, a certified public accountant and personal financial specialist for Pillar Financial Advisors in Waltham, Mass. "You don't have to make any withdrawals and when your children have to make withdraws, they will never be subject to tax." However, charitable contributions will typically get you a bigger tax break when they're donated from a traditional IRA. "If you are intending to leave your IRA to a charity or a nontaxable entity you ought not do a Roth," Gamel says.
Maximize tax-sheltered assets. All of your traditional 401(k) and IRA savings isn't available for spending in retirement. You must use some of the balance to pay income tax upon withdrawal. With Roth 401(k)s and IRAs, you pay the tax using money outside of your retirement accounts. "The advantage of paying the tax with assets that are outside of the tax-sheltered plan is that you get to increase the amount of assets you have in a tax-sheltered plan," says Richard Kopcke, a research consultant at the Center for Retirement Research at Boston College. Your entire Roth IRA balance can be used for retirement expenses.