Roth IRA Advantage and Disadvantages
Retirement is an increasingly important issue in the United States. Today, most Americans are well-versed in the different retirement planning and investment options. One of the most popular ways to save for retirement is the Individual Retirement Arrangement (IRA). Under these arrangements, employees contribute to their IRA accounts as they work, then withdraw funds after retirement. Traditioinal IRA accounts are tax deferred – that is, money contributed to a traditional IRA is not taxed until withdrawn.
With the passage of the Taxpayer Relief Act of 1997, however, a new type of IRA was established. Named for its creator, Senator William Roth, the ROTH IRA has become quite popular in recent years. In contrast to a traditional IRA, contributions to the ROTH IRA are not tax deferred. Contricutions to a ROTH IRA are made with post-tax dollars, and withdrawls from a ROTH IRA typically do not incur additional taxes. For 2010, persons age 49 and younger may contribute up to $5000 to their ROTH IRA accounts, while those over 50 may contribute up to $6000.
There are a number of advantages to a ROTH IRA as opposed to a traditional IRA. Perhaps the biggest advantage is tax-free withdrawls. For a ROTH IRA, contributions can be withdrawn without tax or penalty after a “seasoning period” of 5 years. Moreover, interest earnings can also be withdrawn without tax or penalty after the same seasoning period, so long as the owner of the ROTH IRA is at least 59 years and six months old. Withdrawals from a traditional IRA, in contrast, are treated as ordinary income, and are subject to steep penalties if withdrawn before age 60.
Another major advantage comes into play when it is time for the ROTH IRA owner to buy a home. According to the rules, up to $10,000 may be withdrawn from a ROTH IRA tax and penalty free at any time for the purchase of a home. This feature only applies to first-time home buyers.
There are also several disadvantages to a ROTH IRA compared to a traditional IRA. First, contributions to a ROTH IRA are not tax deductible. A worker who contributes to a traditional IRA enjoys an immediate tax savings, while the ROTH IRA contributor does not. Depending on future expected tax and interest rates, the time-value of the immediate tax savings may outweigh the benefits of tax-free withdrawal later on.
Furthermore, without the tax deductions offered by traditional IRA plans, the ROTH IRA contributor will have a higher adjusted gross income (AGI). As a result, ROTH IRA contributors are less likely to meet the requirements for certain tax credits and other programs.
Deciding which IRA investment plan is right for you can be a difficult decision. It is important to consult with an accountant (CPA) or certified financial planner (CFA), who will help make you make the right choice, and help you get the most out of your retirement savings.
In this article, we have explored the advantages & disadvantages of the Roth IRA.