What is a Roth IRA, and Why do I love them?

A Roth IRA is a retirement account type that may provide TAX-FREE income in retirement!!**

Here is a little breakdown on the differences between a Roth IRA and a traditional IRA, 401k, and 403b:

• Roth IRA** – no initial tax break, but withdrawals can be TAX-FREE in retirement
• Traditional IRA, 401k and 403b* – initial tax break, but withdrawals are taxable in retirement.

Benefits of Roth IRA

Potentially Pay Fewer Taxes

• If you expect to be in a higher tax bracket in retirement than you are today, contributing to a Roth IRA might be for you.
• Also, the longer time frame until you expect to withdraw the money the bigger potential the Roth may have since you could have years or decades of growth TAX FREE.**
• Hypothetical Example:
• $1,000 in Roth IRA grows to $10,000. If you were in 25% tax bracket you only paid taxes of $333 (25% on $1,333 pre-tax dollars to get to $1,000 after-tax dollars)
• $1,000 pre-tax in a traditional IRA, 401k, or 403b grows to that same $10,000. If you were in the 25% tax bracket at retirement you would pay $2,500 (25% on $10,000).
• Even though you are in the same tax bracket and the account grew to the same amount in this example, you would have paid 7.5x the taxes.

Possible Higher Retirement Income

• Hypothetical Example
• The chart below shows how a $6,000 contribution per year to each account, with growth at 6%. The “Post-Tax Value” column shows the effect of paying taxes (at 25%) on your traditional 401k, 403b or IRA savings. When you compare that value to the value in your Roth 401k, 403b or IRA on which you owe no taxes (since you already paid them upfront see the taxes paid column), you start seeing the possible benefit of a Roth.
• This is why every dollar in a Roth account is worth more than a dollar a traditional account.

• This translates into a higher possible retirement income for you as well. The conventional thinking is that if you withdraw 4% of your account annually, it may last 30+ years of retirement. Now let’s look at the Post-Tax Value of a Traditional IRA, 401k, or 403b in the hypothetical example above of $375,645 in 30 years. If we take 4% of this account, it would expect to be able to generate an annual income of $15,025. If we did the same thing with the Roth ($500,859 x 4%), it would be $20,034.

That’s a 33% increase in your retirement income!

Flexibility

• Contributions can be withdrawn out at any time without penalty or interest. When you withdraw the earnings, you must have held the Roth for a minimum of five years and be 59.5 to withdraw growth without taxes and penalties. Some of the exceptions are death or disability of the contributor and first home purchases.
• While this is never a recommended course of action as these accounts are for retirement, it is nice to have this feature in our back pocket in case of emergencies.

Now I know what some of you are thinking, but with the initial tax deduction of a Traditional account, you can afford to contribute more but want to hear a secret…. MOST PEOPLE DON’T DO IT. Do you take your tax refund and save it for retirement? No, it goes towards bills, a car, a vacation, etc. and eliminate the advantage of the traditional upfront tax deduction.

Why do I love the Roth IRA for Teachers?

The pension that you may receive in retirement may mean that your tax rate is not likely to drop much during your retirement, and in fact, your effective tax rate might even increase! Think about it, if the kids are going to be out of the house and will no longer be deductions on your tax return. If the student loans you have been paid off, and you will not have the student loan interest deduction anymore.

So you can see that even though your income may be potentially less, you may not have as many deductions on your tax return. The net result may be a higher effective tax rate in retirement than you are currently in right now. If this is the case, then the Roth might have a strong appeal.

Final Thoughts

A Roth IRA is a valuable tool when thinking about retirement. It could be the right choice if you think your tax rate in retirement will be higher than your current tax rate. They also can make an excellent choice for younger workers while their income is lower. The initial tax deduction isn’t needed, and your money can grow tax-free for years to come.

*Distributions from a traditional retirement account are subject to ordinary income taxes the year distributed. Distributions prior to age 59.5 may incur an additional 10% penalty.

**Distributions of earnings in a Roth IRA are tax free as long as the account has been funded for 5 years and the individual is over age 59.5. Unqualified distributions may incur a 10% penalty. Contributions to a Roth IRA are not tax deductible and there is no mandatory distribution age. All earnings and principal are tax free if the rules and regulations are followed. Eligibility for a Roth account depends on income. Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).

Projections or other information regarding the likelihood of various investment outcome are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. None of the information in this document should be considered as tax advice. You should consult your tax advisor for information concerning your individual situation.