Using A Roth IRA Helps To Prevent Being Totally Molested By The IRS
In Retirement.

For that reason alone... you need a Roth IRA.

This one characteristic makes the Roth unique among the different types of personal retirement savings accounts.

Have no doubt... the IRS will always get it's due.

It does so in the present... and it will do so in the future... when we are in retirement. That we can count on.

Remember the old saying about the two things in life you can always count on... death and taxes.

Well guess what... in a Roth IRA... your money grows "tax free".

That's right... "tax free"... not "tax deferred".

And... the difference that that can make for you at retirement is very significant.

Everyone who qualifies should take advantage of this rare "tax free" opportunity from the government.

Why you need a Roth IRA.

The Roth IRA is just one of many types of retirement savings accounts available for individuals to use to save for retirement.

Contributions to a Roth are made from... earned income that has already been taxed (after tax dollars).

Roth contributions are not tax deductible.

And so... your contributions made to a Roth IRA will have no impact on your tax situation in the current tax year.

In other words... it won't lower your tax liability and it won't help get you a tax refund.

On the other hand... a Traditional IRA... is funded with dollars that have not yet been taxed (pre-tax dollars).

And so... your contributions made to a Traditional IRA can impact your taxes in the current year.

They can help lower your overall tax liability and may help you get a tax refund.

So how do you decide which way to go... a Roth IRA or a Traditional IRA?

I like to ask the following questions...

  • Would you rather receive a small tax refund (or reduction) in the current year?
  • A refund (or reduction) that will do very little to improve either your current situation, your quality of life, or your future?
  • A refund that most people quickly spend... and then can't tell you what they did with it just a short time later?


  • Would you rather be unmolested by the IRS in retirement?

If you prefer to be unmolested... then you need a Roth IRA.

Other common types of personal retirement savings accounts include...

  • the Traditional IRA
  • the 401(k)
  • the SEP IRA
  • the Simple IRA
  • the 403(b)
  • the 457(b)
  • profit sharing plans
  • defined benefit plans

But... only the Roth... allows you to enjoy both "tax free" growth... and "tax free" withdrawals.

All the others... provide "tax deferred" growth. But you will pay taxes (share your wealth) on any withdrawals.

The "tax free" aspect of the Roth IRA provides you a great advantage in retirement investing.

How to use a Roth IRA to lower your effective tax rate.

Using a Roth IRA in conjunction with other "tax deferred" retirement accounts can result in your paying a much lower effective tax rate in retirement.

Consider this...

Let's say that... when you retire...

  • you have a million dollars ($1,000,000) in your "tax deferred" retirement account.
  • Let's also say that you intend to withdraw 6% per year from this account.
  • For a total withdrawal of $60,000 per year.
  • For the sake of simplicity let's say that you are married and file jointly.
  • Let's not consider any other income for this simple example.

Given that scenario... and using the 2008 tax brackets... here is what would happen.

You tax liability at the end of your first year would be...

  • 10% on the first $16,050
  • plus 15% on the next $43,950 dollars.
  • Your total tax would be $1,605 plus $6,592 for a total of $8,197 dollars.

Even though this puts you in a 15% federal tax bracket... as a percentage of your $60,000 withdrawal income your $8197 tax would actually be only about 13.7% of that income.

Your net take home after taxes would be... $51,803.
($60,000 - $8,197 = $51,803)

But what if... instead...

  • You have a half million dollars ($500,000) in your "tax deferred" retirement account.
  • And you have... a half million dollars ($500,000) in your "tax free" Roth IRA.
  • Like before you intend to withdraw 6% from your accounts.
  • $500,000 x 6% = $30,000. $30,000 x 2 accounts = $60,000 total withdrawal per year.

Given that scenario... and using the 2008 tax brackets... here is what would happen.

You tax liability at the end of your first year would be...

  • 10% on the first $16,050
  • plus 15% on the next $13,950 dollars.
  • The total tax on the "tax deferred" withdrawal ($30,000) would thus be $1,605 plus $2,092 for a total of $3,697 dollars.
  • Taxes on the "tax free" withdrawal (the Roth IRA) would be
    $30,000 x 0% = $0.
  • You would end up paying a total of $3,697 in taxes on $60,000 withdrawn.

Your net take home after taxes would be... $56,303.
($60,000 - $3,697 = $56,303)

As a percentage of your $60,000 withdrawal income your $3,697 tax would be slightly less than 6.2% of that income.

You would end up paying... an overall effective tax rate that is actually lower than the IRS's lowest tax bracket...which is 10%.


Here is another way of looking at it...

  • Let's say that you put $500 per month into a retirement savings account for 40 years.
  • Let's assume that you average a 12% annual rate of return on your investment.
  • Over 40 years you would have contributed $240,000 total.
  • And... your account would be worth almost $6,000,000 dollars.

If this account is a 401(k) or any other "tax deferred" retirement savings account... all $6 million dollars will be taxed as it is withdrawn.

Regardless of the tax bracket you may be in at retirement... you will share a significant portion of your $6 million dollars with Uncle Sam in the form of taxes.

Too much of a good thing...
is wonderful.

~ Mae West

But... if this account is a Roth IRA...

What you have is... $6 million "tax free" dollars.

And... Uncle Sam will get none of this money.

The Roth IRA is always superior to the 401K because of this.

That said... here is my advice...

First... fully fund a Roth IRA for yourself and also for your spouse.

Only after that... contribute to a 401(k) or any other available "tax deferred" options you may have.

The only exception would be... if your employer matches your 401K contribution.

If so... you should first fund that plan up to the percentage that your employer matches. Take advantage of that free money.

Once you have obtained the full match from your employer... then send any extra money to your Roth IRA.

Here are the basic Roth rules and other features.

  • Contributions from a Roth must be from earned income from a job.

  • For 2008... the maximum allowed annual contribution is $5,000 for those age 49 and below. Maximum contribution is $6,000 for those age 50 and above.

  • You are eligible to contribute as long as your adjusted gross income is below $101,000 if you are single, and below $159,000 if your married and filing a joint tax return.

  • The contribution limit is phased out incrementally if you make between $101,000 and $116,000 (single) or $159,000 and $169,000 (married - joint).

    If you have a Roth and your income eventually grows beyond the limits... you do not have to cash out the account. You simply cannot contribute any more to the account.

  • Tax free withdrawals can be made from a Roth once you have reached the age of 59 1/2 and as long as your account has been established for 5 or more years.

  • Roth contributions can be withdrawn at any time... tax free and without penalty. And... you are not required to pay the money back.

It is of course best to leave your money in the account to grow for your retirement.

Having a well funded emergency fund and controlling your money
with an effective personal budget should eliminate ever having to dip into your Roth contributions.

But... contribution withdrawal is an option... if there is no other recourse.

Even though contributions can be withdrawn at any time... the same is not true for earnings.

  • If you withdraw any of the earnings before age 59 1/2... you will pay taxes on the withdrawal plus an additional 10% penalty.

  • You can tap your Roth to help buy your first home.

    You can cash out up to $10,000 from your Roth IRA... both tax and penalty free... can include earnings... to help you purchase your first home.

    Again... however... the account must have been opened for 5 years or longer.

    The $10,000 is per individual per account. So couples could withdraw up to $20,000.

Again... I do not recommend doing this.

It is better to save for a down payment separate from your retirement savings.

However... it is an option of the Roth.

  • If you own a Traditional IRA... you're required to begin taking distributions at age 70 1/2. It's called... the Required Minimum Distribution (RMD).

  • This rule does not apply to Roth IRAs.

    You're never required to take distributions from your own Roth IRA.

    If you're able to live on other resources after retirement... you don't have to draw on your Roth IRA at age 70½.

    That means your earnings continue to grow tax-free.

In short, the Roth IRA makes it easier to keep your money in, and also easier to take your money out.

For more information and additional "detail" directly from the IRS... click the link below.

The following PDF file will open...

"Publ 590 Individual Retirement Arrangements (IRAs)"

You will need Adobe Reader (the latest version is recommended) installed on your computer in order to open this file. You can get a free version of Adobe Reader here (a new window will open so you can download without leaving this page).

In order to print, open the downloaded file, and select the "Print" option from the menu.

If you haven't yet opened a Roth IRA for yourself and for your spouse... do it now.

Set it up to automatically draft your bank account monthly. Funding your Roth IRA is too important to be left to a monthly choice.

The Roth IRA retirement account makes it easier to build, preserve and use your retirement savings.

"Because It Matters"... Jim

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