Choosing retirements plans can easily be confusing, especially if you’re new to financial products like the Roth IRA. But, you should understand investments can also be taxing, because they are taxable. The trick is selecting tax-sheltered retirement savings plans. Uncle Sam provides you great opportunities to put money into tax-sheltered retirements savings in by means of Individual Retirement Plans and they give you a double-barreled tax break from these plans:
There’s an upfront deduction for the cash you put in.
All of the money in the plan builds up tax-free until you withdraw it after age 59 1/2.
That’s excellent news. The unfortunate news is that every cent you withdraw from a retirement plan is taxed as ordinary income at rates up to 40%. You retire, your paycheck stops and suddenly you are faced with insurmountable tax bills. It just doesn’t seem fair. If you’re someone that owns a mutual fund outside an IRA, any growth in value would be a capital gain, taxable at rates up to 20%. Own the same fund inside your IRA and you don’t qualify for the capital gains rate but are taxed at the higher ordinary income rate.
Discover A Roth IRA
Let’s take a look at the Roth account, created by Congress in 1997, which amounts to a tax-free retirement savings account. Put after-tax money into a Roth, leave it there for five years, and it will never be taxed again. If the IRS knocks on your door, just say: “Keep your hands off my retirement savings.” That’s to code to make them go away – really.
IRA Class Instruction 101
The 2001 tax law increases the amount you can contribute each year to both a Roth IRA and a regular IRA. New maximum contribution to all IRAs is $5,500 (under age 50) and $6,500 (age 50 and over) a year from 2016, with income requirements depending on tax-filing status. There’s no upfront deduction for contributions to a Roth since it was purchased with after-tax dollars and all the money this account keeps building up is tax-free forever.
— You must start withdrawing from other retirement plans at 70 1/2. You don’t ever have to withdraw money from a Roth. If your taxable income is under $100,000 you can convert your regular IRA to a Roth IRA. You’ll own taxes on what you convert. But once you pay that tax, you’ll never pay taxes on that money again–no matter how big your account grows.
However, there’s one drawback. You can only make the full contributions to a Roth IRA if your taxable income is under $150,000 (married) or $95,000 (single). You can’t contribute to a Roth at all if your income tops $194,000 (married) or $132,000 (single).
Making the Most of It
Here’s how to get maximum mileage from the Roth IRA:
- Use it for high-return investments such as growth stocks or growth mutual funds. Zero taxes on your gains is even better than the 20% maximum capital gains rate.
- If you get a bonus or other found money, put it into a Roth account and let it grow, tax-free.
- Money earned by a child can go into a Roth IRA and accumulate, tax-free, for the next 50 – 60 years.
Resources to help you:
Rules and Contribution Limits – Good Financial Cents
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