COLLEGE STATION When retirement is still a long way off, it’s often hard to focus on the details that get you there. But some opportunities are just too good to pass up, says Certified Financial Planner Nancy Granovsky.
“One of the best opportunities is the Roth IRA,” says Granovsky, family economist with the Texas Agricultural Extension Service.”This type of Individual Retirement Account allows earnings to build up tax free, even when they are drawn out during retirement.”
The Roth IRA is still fairly new to consumers. Introduced by the Taxpayer Relief Act of 1997, it became effective in 1998. Consumers can deposit as much money into a Roth IRA as into a traditional IRA, but that’s where the similarities end.
Under both plans, the money must come from earned sources, not invested sources. The amount of money deposited in either type of IRA cannot exceed $2,000 per year or 100 percent of your earned income.
“This means that even part-time work can make you eligible to have an IRA, although if you make less than $2,000 during the year, you couldn’t deposit more than you made into your IRA,” Granovsky adds.
Most taxpayers, unless their incomes are unusually high, will qualify to have a Roth IRA. The maximum annual contribution starts to be phased out for single taxpayers with modified adjusted gross income between $95,000 and $110,000. For married taxpayers filing a joint tax return, this phase-out begins with modified adjusted gross income between $150,000 and $160,000 per year.
In some cases, contributions to a traditional IRA may be tax-deductible, but they are never tax-deductible with a Roth IRA. But that doesn’t keep a Roth from being a good deal for most workers, notes Granovsky.
“The Roth wins out over time. It continues to grow tax-free inside the IRA, while the traditional IRA grows tax-deferred. When you start withdrawing money from a traditional, deductible IRA, you’ll have to pay taxes on what you withdraw. Even with a traditional, non deductible IRA, you’ll still pay taxes on the earnings you withdraw.”
Withdrawals from a Roth IRA are completely tax-free. Under the rules of Roth IRA’s, the only time taxes are paid is when the Roth IRA is opened.
“That’s a valuable difference, because as the value of your account grows over time, you will not have to pay additional income taxes.”
With both traditional IRA’s and Roth IRA’s, money can be withdrawn without penalty as soon as the consumer reaches age 59-and-a-half. However, with a traditional IRA, consumers must begin to withdraw money the year after they turn 70-and-a-half. With a Roth IRA, such withdrawals tied to age are not mandatory. This means that Roth IRA nest eggs can continue to grow if consumers do not need to tap into them to meet retirement income needs.
Although the primary reason to invest in a Roth IRA is to save for retirement, sometimes the funds are needed for other purposes. Under certain conditions, money can be withdrawn before age 59-and-a-half from a Roth IRA without penalty. Withdrawals for a first-time home purchase (up to a lifetime limit of $10,000 per IRA holder) can be made tax-and-penalty free so long as the account has been in existence for at least five years. If the shareholder dies or becomes disabled, there is no tax or penalty for withdrawing the money from the Roth IRA. Penalty-free withdrawals are also allowed at any time to pay for higher education expenses.
“Before withdrawing funds from a Roth IRA, check with a tax advisor for official tax assistance and interpretation of the rules regarding distributions,” cautions Granovsky.
The best time to open a Roth IRA is as early in the tax year as possible. Opening an account early will let your money grow tax-free that much longer.
There are numerous investment choices for Roth IRA’s. In addition to options available from financial institutions, consumers may wish to consider investing in a mutual fund.
“With any investment, beware of the risks, fees and other costs associated with the investment,” says Granovsky.
A popular investment for IRA’s is an indexed mutual fund, whose investment portfolio mirrors the performance of a major index, such as the S&P 500. The return on an indexed portfolio will rise and fall with market performance. To compare investment costs among various mutual funds, use the Mutual Fund Cost Calculator provided by the Securities and Exchange Commission (http://www.sec.gov/mfcc/mfcc-int.htm). Check out the Web site to determine the cost/fee information you will need to obtain from the mutual funds you are considering for your investment. After you obtain the information, go back to the Web site to make your comparisons.