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In
this chapter:
Introduction
Retirement
savings plans
The
401(k) plan
IRAs
Roth
IRAs
The
IRA decision
How
your savings grow
Some
(minor) drawbacks
Dividing
your savings
Inflation
& taxation
A
newfangled pension
Questions
& answers
Security
and your 401(k)
The
scoop on IRAs
Your
savings priorities
If
you're self-employed
Financial
cramming
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1
2
3
4
5 6
7
8
9
10
11
12
13
14
15
16
17
Roth
IRAs
Roth
IRAs are a breed unto themselves. Unlike 401(k)s and deductible
IRAs, Roth IRAs don’t give you an immediate up-front tax break
on your contributions. But once your money is in a Roth IRA, it
will never be taxed again. Roth IRAs don’t just compound tax-free:
They stay that way. Forever. When you retire and start taking
your money out of a Roth IRA, you won’t have to pay federal taxes
on it as you would with a traditional IRA or a 401(k). In retirement-plan
lingo, 401(k)s and deductible IRAs offer tax-deferred growth
(meaning you delay paying tax on your contributions and earnings),
while the Roth IRA offers tax-free growth. For many people—especially
young people saving over many years—the Roth IRA may be the better
deal. (I’ll get into the gory details of why in a moment.) One
big advantage is that you may be able to open a Roth IRA even
if you already have a retirement plan at work, which you may not
be able to do with a deductible IRA.
The
eligibility rules for Roth IRAs are simpler than they are for
deductible IRAs. It doesn’t matter if you and your spouse are
eligible for a retirement plan at work—all that matters is your
income. You can make the full $2,000 contribution to a
Roth IRA if:
you’re
single and your adjusted gross income is not more than $95,000;
you’re
married, file jointly, and your adjusted gross income is not more
than $150,000.
You
can contribute less than the full $2,000 if you earn under $110,000
as a single person, or $160,000 as a couple filing jointly.
Married
people filing separately can never make the full Roth contribution,
but can make partial contributions if their adjusted gross incomes
are less than $10,000. (Pretty stingy.)
The
Choice: Which IRA Is Right for You?
If
you want to put money in an IRA, you’ll need to decide which kind.
Roth IRAs are often considered the better option for younger people.
Here are some of the questions you should be asking yourself.
Do
I qualify for a deductible IRA? Deductible traditional IRAs
have relatively low income limits, so you may not qualify for
the full $2,000 deduction. Partially deductible IRAs and non-deductible
IRAs involve a huge amount of paperwork and confusion, and are
more trouble than they’re worth. No mystery here: If you can’t
deduct your full contribution, go with the Roth.
Can
I afford to make the full $2,000 contribution if I go with a Roth?
Roth IRAs pay off big in the long run, but they may require
some belt-tightening today.
If
you’re in the 28% tax bracket and you deduct your contribution
to a traditional IRA, a $2,000 contribution would give you a
$560 tax deduction. So the $2,000 contribution would end up
costing you just $1,440. But Roth IRAs are not deductible, which
means your $2,000 contribution to a Roth would cost you … $2,000.
If you can afford to put the full $2,000 in a Roth IRA, you’ll
be doing your future self a big favor. But if you can only afford
to put $1,440 in your account either way, the Roth IRA won’t
provide you with much financial advantage in the long run. In
that case, your decision will be based on other considerations,
like the ones in the next three points.
Will
I be in a substantially lower tax bracket when I retire? Many
people fall into a lower tax bracket when they retire because
they stop receiving regular income from their jobs. (Now there’s
a cheery thought.) Of course, it’s hard to predict today what
your tax situation will look like thirty or forty years from
now. But here’s the general concept: Roth IRA contributions
are taxed today, while deductible IRA contributions are taxed
when you take them out. So if you suspect that you will be in
a lower tax bracket when you retire than the one you are in
today, a deductible IRA might make more sense.
Will
I need my IRA money right away when I retire? Again, no
one can be sure about the answer here, but it’s worth thinking
about. With traditional IRAs, you are forced to start withdrawing
your money once you hit the age of 70. Roth IRAs have no such
requirements, which could be a big advantage if you can afford
to delay making your withdrawals. The longer you leave your
money in an IRA, the more it can grow.
Will
I need to withdraw my IRA money before I retire? You can
withdraw the money you have put into a Roth IRA at any time
without penalty (though you will have to pay a penalty if you
withdraw any of the earnings on that money). Though this is
not advisable—once you have taken the money out, it can’t be
replaced—it does provide more emergency protection than a traditional
IRA.
My
advice generally is to put as much money as you can afford in
a Roth IRA and leave it there. But if you have reason to believe
that a deductible IRA would be better for you, look into the question
before you make any decisions. Financial magazines like Money
(www.money.com)
and Smart Money (www.smartmoney.com)
have run helpful articles on the subject that can be accessed
on their Web sites. You should also check out the IRA comparison
calculators available at sites like www.financenter.com
and www.datachimp.com.
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