Why Consider a ROTH IRA
You’re in a stable career, a long way from retirement, and you’ve got your personal life (relatively) in order. You’re really hitting your stride from a weather‐the‐storms‐of‐life perspective. Before you know it, cash is building up in your checking account, much more than you’d need if, say, life inconveniently places a telephone pole in the path of your sedan or if you have to dig into your reserves for several months while you search for a new job. What do you do with your excess money? What do you do with the money you have in the bank above and beyond your emergency fund?
The answer to that question depends primarily on who’s responding, but I’m here to argue that if you’re an equity investor – that is, if you’re comfortable with the risks involved in the stock market – you may want to consider a Roth IRA.
From someone peripherally aware of IRAs, the immediate objection will be thrown up that bank accounts and IRAs are two savings vehicles with opposing functions: bank accounts are for money you’re going to use soon and IRAs are for money you’re going to squirrel away for decades to be used once you’re too old (or don’t want) to work. What if you need to get to the money in your IRA? After all, if you pull money out of an IRA before retirement, don’t you have to pay a penalty?
When it comes to Roth IRAs, the answer to that is both yes and no. Any earnings on the capital you contributed to a Roth IRA will be taxed in addition to being penalized at 10% if you pull it out before five years or before reaching age 59½, whichever comes latest. You can, however, code a withdrawal from a Roth as a “contribution,” meaning you’re just taking the money out that you’ve contributed – not the earnings on that money. For this type of withdrawal, there is no penalty. On top of that, Roth contributions have already been taxed to begin with, meaning that when you take an eligible distribution from a Roth (after age 59½) or when you make a withdrawal of contributions whenever, there are no tax consequences.
For those of you still scratching your heads, here’s an example: You contribute $5,000 to a Roth, and a year later it’s grown to $6,000. Unfortunately, life throws you a curve ball and you need more money than you have on hand at the bank, requiring you to pull $2,000 from your IRA. If this were a traditional IRA, you’ll be taxed at your current income tax rate and penalized an additional 10% on the $2,000 that you withdraw. But since this is a Roth IRA, you can designate the withdrawal as a withdrawal of contributions, which have already been taxed at the income tax rate you paid in the year you contributed it and to which the 10% penalty doesn’t apply. If you pulled out all $6,000, then the $1,000 in growth would be taxed and penalized – but find me a savings account where it’s possible to achieve that sort of growth in a year. Best‐case‐scenario right now, your savings account would have grown from $5,000 to $5,050.
Long‐story‐short: if you’ve got money that isn’t budgeted for the next 6 to 12 months, if you understand the necessity of investing over the long‐term, and if you’d like a tax‐free source of income for your golden years, then consider putting in the work now to build a Roth that can make everything simpler later.
Bob Gardner, AAMS
Financial Advisor
Armada Investment Partners of Raymond James
Disclosures: Opinions expressed are not necessarily those of Raymond James & Associates. The information provided is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. The hypothetical example is provided for illustrative purposes only. It is not intended to reflect the actual performance of any security. Investments involve risk and you may incur a profit or a loss. Roth IRA owners must be 59½ or older and have held the IRA for five years before tax‐free withdrawals are permitted. Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free.
