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The Roth IRA is a great opportunity for savers.  While you are still in a low tax bracket, you can stash away money and never have to pay taxes on it again.  Take advantage of it now before you are disqualified based on your income.

Pros

Here are the benefits of a Roth IRA for growing families:

• Pay taxes once and you are done: If you are currently in a low tax bracket, this is the time to pay your taxes and get them over with.  You could end up with more in retirement.
• Get help with a 1st time home purchase:  You can use up to $10,000 of your Roth IRA to buy your first home without any penalties, if you do it 5 years after you put the $$ in.
• Pile on the savings:    Even if you contributed to a 401K or traditional IRA, you can top-off your savings with a Roth IRA.
• Be in control:  You get to decide when to withdraw money.  IRA and 401Ks have a minimum distribution rule after you reach 70.5 years of age. This lets you control what tax bracket you are in during retirement and keep more of your money!

Limitations

There’s no free lunch forever.  The IRS did put some limitations in and here they are.

• Maximum Contribution:  The most you can put in is $5,000 if you are 49 years old or younger.  Otherwise, the limit is $6,000.
• Income Limits: For single folks, you can contribute if you earn less than $105,000.  For married tax filers, the limits is $166,000.

Case Study

Here’s a real-life example.  Josh is 26 and earning $85,000 each year.  He’s doing well and savings $7,000 each year. That’s even after contribution $16,000 to his 401K account.  He’s hoping to buy a condo sometime and eventually get married after he meets the right person.   So far, he’s been letting the money pile up in his savings account.   While he’s not earning much on that cash, at least he hasn’t blown it on a new sports car yet.   He knows the temptation and wants to save it, but he doesn’t know what the options are.

If he takes $5,000 and saved them in each of the following vehicles, here’s how he would have ended up at retirement at age 65.

1. Roth IRA: $69,974.  Puts it in a stock market index fund with an assumed 7% return which is the long-term historical average for stocks.
2. Regular (Taxable) Brokerage Account: $41,866.  Also puts it in a stock market index fund for an expected 7% return.  This time he has to pay taxes each year on dividends and capital gains tax at the end.  This is $28,108 less than the Roth IRA.  Ouch!
3. Traditional IRA: $60,578.   By contributing $5,000, he got pay $1,000 less taxes so this is effectively $6,000 saved.  He puts it in the same stock market index fund, but has to pay taxes when he withdraws it.  At that time, he is in a higher tax rate 30%.  This is $9,396 less than the Roth IRA
4. Savings Account: $12,609. Earning 3% interest, this is 2.4% after taxes.  This is $57,365 less than a Roth IRA.

While Josh is young and in a low tax bracket, he is better off by paying his taxes now and not having to pay them later.  He can also use the Roth IRA to help him purchase that condo in 5 years without any tax penalties.  That’s a major bonus!