Tax season is too often a time of four-letter words. But there’s a positive one that you might want to add to the list: the Roth.
Savers have been able to contribute to a Roth individual retirement account since early 1998, but the rules and the retirement landscape have changed significantly since then. Increasingly the Roth is turning into a vehicle that many can use to save more money — or save somewhere else — for retirement. Obviously there are no one-size-fits-all answers here.
Do you do the Roth? The 401(k)? Or both?
A friend recently wondered if she should open a Roth IRA. She went online to bump up her 401(k) contributions, and the 401(k) website mentioned Roth IRA options. What to do?
Many advisers I spoke with said most people should contribute first to their 401(k) plans in order to snag any matching contributions that their company might offer. After all, if the 401(k) plan offers 50 cents or $1 for each dollar you put in, up to a set percentage, you grab that money.
Frank Migliazzo, managing director of the Migliazzo Group, Merrill Lynch Private Banking Group in Troy, Michigan, said he’s told his children, who are just beginning their working careers, to save in that 401(k) first. If it’s a larger 401(k) plan, the fees often can be less expensive, too.
Yet “not every employer has a 401(k),” Migliazzo said. And not every employer offers a match.
You could look into a traditional IRA, especially if you meet various limits and would be able to take a tax deduction for a contribution. You can’t make regular contributions to a traditional IRA in the year you reach 70½ and thereafter.
Roth IRA contributions aren’t tax-deductible. But Migliazzo said many younger consumers could want to set up a systematic plan where they contribute $50 a month or so to a Roth IRA in order to take advantage of the tax-free features of the Roth.
“The big advantage of the Roth is that it’s totally tax-free — if the government doesn’t change the rules on this,” Migliazzo said.
If you pay attention to the rules, you typically do not pay taxes on withdrawals from a Roth IRA in retirement, and there are no minimum distributions required from a Roth IRA while the owner is alive.
Under a Roth IRA, a saver can contribute up to $5,500 — or up to $6,500 if age 50 or older — in a given year, if one’s income falls within certain limits. Single filers with modified adjusted gross incomes below $131,000 in 2015 can make at least a partial contribution. Married couples filing jointly can make at least a partial contribution if their modified adjusted gross income is less than $193,000 in 2015.
The phase-out — which means that only partial contributions can be made — begins at $116,000 for singles in 2015 and $183,000 for married couples in 2015. (The income limits for the phase-out range go up by $1,000 in 2016.)
One can still contribute to a Roth IRA for 2015 by the tax deadline this year of April 18 for most of the country. You’re able to open a Roth IRA even if you have a retirement plan at work.
Christine Benz, director of personal finance for Morningstar, said one of the key benefits of the Roth is that you can withdraw contributions made into a Roth IRA at any time for any reason tax-free. But various rules apply to withdrawals of earnings from that plan in order for those withdrawals to be tax-free.
“Maybe think of your Roth as a way to back up your emergency fund,” Benz said.
One big advantage of the 401(k) savings plan is that it enables you to reduce your current tax bill by contributing money on a pre-tax basis into your 401(k) plan. The maximum amount of money that most people can set aside in a 401(k) in 2016 is $18,000 — the same amount as in 2015. Savers age 50 and older who are working can contribute another $6,000, making their maximum up to $24,000.
What’s your tax rate likely to be in retirement?
One of the big reasons to go with a Roth is if you think your income tax rate will be higher in retirement than it is today while you’re working.
Benz suggests a perfect Roth IRA candidate: Take a young woman who is 25 and working, studying for an MBA at night and planning to go into management to make far more money in the next 10 years. Her tax rate is bound to go up.
Stuart Ritter, vice president and senior financial planner for T. Rowe Price, said those in their 40s and 50s can consider a Roth, as well, as a way to control their taxable income in retirement.
Spending is not a constant in retirement. Some years you might have a major medical bill or want to take a once-in-a-lifetime trip to China.
If you had some money in a nontaxable Roth account you could juggle where you get your money. One huge withdrawal from the 401(k) in a year could be avoided and it wouldn’t push you into a higher tax bracket in a given year.
Ever think of a retirement plan for the kids?
Fidelity Investments recently launched its own “Roth IRA for Kids” that has no account minimum or maintenance fees. If necessary, the child can withdraw the funds penalty-free for a first-time home purchase (up to $10,000) or in the case of qualified higher educational expenses.
Keith Bernhardt, vice president of retirement and college products for Fidelity, said parents and grandparents are looking for ways to give children a head start.
Bernhardt said he put about $225 into such a custodial account for his 13-year-old son, who earned money shoveling snow. If the child has income on a W-2 form, it’s clearly doable. If the child has baby-sitting or snow-shoveling money, you would want documentation that the child earned money and you could want to talk to a tax professional about setting up such an account, Bernhardt said.
“Money can only go into the account if the child has earned income,” Bernhardt said.
And there’s what some call a Roth IRA with training wheels.
Beginning this tax season, savers can use federal income tax refund money to contribute to a new starter Roth account called myRA — which is offered by the U.S. Department of Treasury.
You’d check the savings box in the refund section of your tax return. You also can contribute directly to your myRA account from your checking or savings account.
The myRA is an option for savers who do not have access to a 401(k) or who lack other options to save. You could contribute if you earn an annual income below $131,000 if single, or $193,000 if married and filing jointly, in 2015.
There are no fees and no minimum contributions. But you don’t get a choice on how to invest the money here and the returns aren’t huge. Interest earned in a myRA account is at the same rate as investments in the Government Securities Fund, which earned 2.31 percent in 2014.
Don’t overlook the Saver’s Credit.
Workers who are 18 and older, not full-time students and don’t make much money should look into the Retirement Savings Contributions Credit.
The amount of the credit is 50 percent, 20 percent or 10 percent of your retirement plan or IRA contributions up to $2,000 (or $4,000 if married and filing jointly). But tighter income limits apply. You would not qualify for any credit if you had an adjusted gross income that was more than $61,000 in 2015 if married filing jointly.
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