To Roth or not to Roth
Many people are familiar with a Roth IRA. Put money away, after taxes are paid on those earnings, let the money grow tax differed in the IRA, then take tax-free distributions of the earnings.
Not a bad deal, lets go through it again.
Pay taxes on all $40,000.
Put $5000 into Roth IRA, after tax.
$5000 grows to $75,000 over your lifetime.
Take original $5000 out – taxes were paid when that money was earned. Take $70,000 tax-free. Nothing due on earnings.
In a regular IRA you put $5000, before taxes, from earnings into same investments in IRA, grows to same $75,000 over time. Then pay taxes on all $75,000 when taking it out of IRA.
Pay taxes now on $5,000 and nothing later,
$70,000 distribution – tax-free.
Pay no taxes now on $5000 and pay taxes on full $75,000 taxable distribution.
Seems fairly straight forward, especially if you think taxes will be the same or possibly higher when you retire.
Here is where it gets interesting.
A Roth IRA has earnings limitations. If you earn over $120,000 as a
single person, or over $177,000 as a married person, you can not make a Roth contribution. Tough luck.
Making an employee contribution into a Roth ‘bucket’ in your 401(k) has no earnings limitation. You can put full employee contribution into the Roth ‘bucket’ not just $5,000.
If you earn $200,000, are over age 50, you can put $22,000 into the Roth 401(k) at work.
In 25 years that $22,000, earning 6% grows to $94421.16. The $22,000 had taxes paid when earned, but the growth $72,421.16 is never subject to taxes.
I’d call that the best kept secret out there.
This is an example and anyone interested in further information should contact a registered financial advisor, or ask about a Social(k) 401(k) / 403(b) at work.