If the idea of tax free retirement income appeals to you, you should consider Roth accounts. With a Roth account, you put money in after tax, it grows tax free and you take it out tax free. Traditional accounts (IRAs, 401Ks, 403bs, 457s without the Roth name attached to them) are the opposite. You get a tax deduction now when tax rates are low, the money grows tax deferred and when you take it out you are taxed at whatever the government decides tax rates will be, probably much higher. We are near historic low tax rates now and federal spending will go way up as Baby Boomers age and collect on Social Security and Medicare and Medicaid. Where will they get the money to pay for these programs?
If you have a big balance in a traditional account and take distributions in retirement while drawing Social Security, you will pay taxes on your withdrawals at increasing tax rates and probably pay taxes on your Social Security. If however you have your money in a Roth account and pull it out while taking Social Security, the withdrawals from the Roth account will be tax free and you probably won’t pay tax on the Social Security unless you have significant other taxable income. For this very reason I am on a crusade to help people with large traditional accounts to see the value of converting their money from their traditional accounts to Roth accounts, thereby saving them tons of money over the rest of their lives.
With traditional accounts, you must take Required Minimum Distributions. These will start at 3.65% of your account balance and the percentage goes up each year. The government wants your money. With a Roth account, you do not have to withdraw your money if you don’t want to. When you die and leave a Roth account to an heir, the heir will have to take Required Minimum Distributions starting at their age. The great thing is the money will be tax free to them. That is a great inheritance! If they inherit your traditional account, they will have to pay taxes on the withdrawals they will be forced to take. If a spouse inherits the Roth from the other spouse, the living spouse does not need to take RMDs.
There is an important thing to remember with Roth accounts. You can’t take the earnings out within the first 5 years of opening the account, unless you pay a penalty for early withdrawal. You can take your contributions out early, not the earnings, click here to learn more about Personal Finance .
I hope you can see the power of the Roth IRA. They are important elements of wealth building.
By: Bob Mackenzie founder of Lifetime Safe Income a noted financial services firm located in the Denver Colorado area.