I’ve saved the best for last. The Roth IRA is the second most important type of retirement account for the young professional, behind only your 401k. Roth’s are incredibly important due to their favorable tax treatment by the IRS. Roth IRA’s aren’t tax deductible., instead, tax is paid on contributions while qualified withdrawals are tax free. What this means for young professionals is that decades of growth can be tax free. Another plus for young professionals is that they are able to take advantage of their low tax rate, rather than pay taxes on withdrawals when they’re in a higher tax bracket. Roth IRA’s allow young professionals to take advantage of the lower earnings at the beginning of their careers. Another advantage to Roth’s is that, unlike Traditional IRA’s, there are never required minimum distributions.
The taxation of Roth IRA’s is fairly simple. Contributions still count towards ordinary income and contributions don’t create an income tax deduction. Contributions grow tax free, which is the biggest benefit to using a Roth. Over a lifetime, this tax free growth can create real wealth. Below I’ve included a graph which gives you an idea of how a Roth IRA can be advantageous. As you can see, the difference between the Roth and the taxable account isn’t much in the beginning but the difference is compounded over time and ends up being almost $300,000 greater by the end. That’s a considerable amount of money, particularly when you consider that this graph only goes out to 21 years; in reality the actual time frame for investing will probably be closer to 30 years or more for the average young adult.
Roth IRA’s aren’t only beneficial for young professionals though. They’re great for anyone who expects to be in a higher income tax bracket during retirement. They also benefit those who believe that tax rates will be raised prior to their withdrawals. Unlike Traditional IRA’s, Roth’s do not have a Required Minimum Distribution at age 72. This is important because it allows growth to continue until the funds are required.
Roth IRA’s have some requirements which must be met in order to use them though. Your AGI has to be under a certain amount, based on your tax-filing status. Another requirement is that you have to be employed in order to contribute to a Roth. The Maximum contribution is $6,000 per year, or your taxable compensation if your compensation is less than $6,000. A catch-up contribution of $1,000 is allowed for those 50 and above, the same as the Traditional IRA. A note about IRA contributions though; the $6,000 limit applies across both types of IRA. This means that the total contributions to both accounts can only add up to $6,000.
All in all Roth IRA’s can be a great choice for many young professionals. The combination of tax free growth is hard to beat. If you have specific questions about opening a Roth, you can set up a call with me HERE.