The Roth IRA

The Roth IRA is a retirement savings vehicle that allows you to save for retirement with tax-free growth. There is no tax deduction allowed for a contribution made to a Roth IRA, but all earnings and withdrawals from the account are tax-free after age 59 1/2. The current annual contribution limit to a Roth IRA account is $6,000 ($7,000 if over age 50). Additionally, there is also a Roth 401-k which has the same annual contribution limits as a traditional 401-k, if you would like to put away even more for retirement.

 The typical argument in favor of tax-deferred retirement vehicles is that you are likely to be in a lower tax bracket at retirement than you are now in your working years. I have a couple problems with this argument. First, especially for people far away from retirement, we have no idea what the tax law or tax rates are going to be when we retire. They could be significantly higher at retirement. Second, during retirement you are likely to lose many deductions and credits you have during your working years, which will increase your tax rate.

Let's take a look at just how powerful a Roth can be when you consistently contribute to it. If you annually contribute $6,000 from age 30 to 65 earning a conservative 8% growth, the value at age 65 would be $1,033,901. What if you did a little bit better at 10% growth? You'd have $1,626,146. How about if you don't start contributing until age 40? You would still have $438,636 tax-free at 8% growth. Being consistent and setting aside a small amount each month can pay huge dividends later on.

An additional benefit of the Roth is that during retirement when you are collecting Social Security benefits, those benefits are taxed between 0 and 85%. The lower your other earned income, the lower the tax will be on the Social Security benefits. The distributions from a Roth IRA will not be taxable income and thus not increase the amount of tax on Social Security benefits.