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Roth IRAs: A Tool For Retirement Savings

Roth IRAs allow taxpayers to invest up to $2,000 of after-tax dollars each year for retirement. Roth IRAs are generally preferable to traditional IRAs, particularly for individuals or couples who do not qualify for a tax-deductible traditional IRA. Two general exceptions are taxpayers that expect to be in a much lower tax bracket during retirement and those who expect to withdraw funds within ten years.

Contributions for 2001 Roth IRAs can be made from January 2, 2001 to April 15, 2002. The earlier someone makes a contribution, however, the faster his or her deposit begins to earn compound interest. Full Roth IRA contributions are available to all workers with earned income, regardless of age, providing their adjusted gross income (AGI) is under $95,000 for singles and $150,000 for joint filers. The $2,000 contribution limit is phased out (i.e., prorated) between AGIs of $95,000 and $110,000 for singles and $150,000 and $160,000 for couples filing jointly.

Although contributions to a Roth IRA are not tax-deductible, earnings grow tax-deferred and withdrawals are tax-free if made more than 5 years after the Roth IRA was established and the taxpayer has reached age 59½, becomes disabled, or dies. Another big plus is that, unlike traditional IRAs, investors in a Roth IRA are not subject to the minimum distribution rules, and workers can make contributions after age 70½ (for themselves and a spouse) if they continue to work and have earned income.

Investors can roll funds over from a traditional IRA to a Roth IRA, provided the taxpayer's AGI is $100,000 or less and he or she is not a married individual filing separately. Taxes must be paid on the amount of the conversion, in the year that the conversion is made. To determine if converting from a traditional IRA to a Roth IRA will result in a decrease in taxes, check one of the IRA calculator links on the Web site www.rothira.com.

People often wonder whether they should save for retirement in a tax-deferred employer plan (e.g., 401(k) or a Roth IRA). Most financial experts advise first making a tax-deductible contribution to an employer 401(k) retirement plan that takes full advantage of employer matching (e.g., contributing the first 6 percent of pay). Employer matching is "free" money and is superior to any other alternative. A 25 percent match, for example, is equivalent to earning a guaranteed 25 percent return on an investment. A 50 percent match is like a 50 percent return.

Contribute your next $2,000 a year to a Roth IRA. A Roth IRA is generally a better option than a 401(k) for the next $2,000 (after the amount that an employer matches) because, unlike employer plan earnings, which are taxed at ordinary income tax rates on withdrawal, earnings in a Roth IRA can be withdrawn tax-free. This will result in a higher annual after-tax income than a taxable 401(k).

Finally, contribute additional funds to an employer 401(k) up to the maximum contribution allowable (or that you can afford). For 401(k) and 403(b) plans in 2001, this amount is $10,500. If you still have money available to invest tax-deferred, consider fixed or variable annuities.

To maximize investment earnings, purchase annuities with low operating expenses and good historical performance and hold variable annuities for at least a decade. Another tax-deferred investment option is a simplified employee pension (SEP) or Keogh for persons with self-employment income.