Getting in on the party as Roth IRA celebrates 10th anniversary
Posted on 30 July 2008
Permanent URL of this article: http://retirementrevised.com/column/getting-in-on-the-party-as-roth-ira-celebrates-10th-anniversary
The Roth IRA is celebrating its 10th birthday this year.
Brought into this world by the Taxpayer Relief Act of 1997, Roths were first brought to market in 1998. Since the legislation was passed in early August, it’s a good time of year to blow out some birthday candles and take a look at how this useful tool for retirement planning is faring in adolescence.
You can’t contribute pre-tax dollars to a Roth. While that might sound like a disadvantage, Roths have a lot of positive features that can counterbalance the loss of pre-tax dollar investing.
Roths have been growing quickly in recent years, but overall are still somewhat under-appreciated. Only 15 percent of American households owned a Roth IRA in 2007, according to the Investment Company Institute–probably because they are much newer than traditional IRAs and less understood.
However, Fidelity Investments notes that new IRA account openings–and overall IRA dollar investments–have favored Roths for the past two years running. “We think that within five years, we’ll have more Roths than traditional IRAs,” says Bill Hunter, vice president of retirement products at Fidelity.
Most U.S. households are eligible under Roth IRA income level caps. If you’re single, you can contribute if your adjusted gross income is less than $101,000, and you can make a partial contribution if your income is below $116,000. For joint filers, the income caps are numbers are $159,000 and $169,000, respectively. And income limits will be lifted in 2010 for investments in Roth 401(k) accounts.
Roths are more popular with younger investors, who tend to be in lower tax brackets and could reasonably expect taxes to be higher down the road when they retire. But Roth IRAs are worth considering even if you’re close to retirement, or already have retired. Here are some key points to consider:
Tax planning. Traditional IRAs and 401(k) plans are an essential part of any retirement savings plan–but they’re not the complete answer. Withdrawals from tax-sheltered accounts are taxed as ordinary income upon withdrawal, since no taxes were paid on these dollars before they were invested.
That can have negative consequences for your overall tax situation in retirement, since your brackets can be somewhat fluid after you stop working. Sometimes, taking a distribution from a tax-deferred account can put you into a higher bracket than you want to be in, boosting your tax bill.
With a Roth IRA, you’ve paid the income tax upfront, since you invested post-tax dollars. That means your withdrawals are tax-free, so long as the account has been open five years and you are at least 59 1/2 years old.
Roths also can be a good tax hedge if you believe–as I do–that today’s historically low federal income tax rates are destined to rise in the years ahead. Why? The federal government is awash in trillions of dollars in debt, Medicare and Social Security programs both face major fiscal problems that will have to be fixed–and they are projected to consume about three-quarters of all federal spending by the middle of this century.
If you think taxes will be higher when you retire than they are today, you can use a Roth to take adantage of today’s lower rates.
Flexible withdrawals. Unlike traditional IRAs, you aren’t required to take annual distributions from a Roth when you turn 70 1/2. That gives you the potential to keep more of your money invested and working for you. That can give a boost to your long-term retirement security–especially if you expect to live a long life.
Employer-sponsored plans. Employers can offer Roth 401(k) options under provisions of the Pension Protection Act of 2006. Unlike regular Roths, eligibility isn’t tied to an income cap, although you’re still subject to overall limits on annual 401(k) contribution amounts. With a Roth 401(k), you get the additional benefit of access to your employer’s fund options, which generally are high quality and have lower fees. And, you can mix and match Roth and traditional contributions within your employer’s plan.
So far, only about 20 percent of employers have added Roths to their benefit plans, according to Alison Borland, who heads the defined contribution practice at Hewitt Associates, the benefits consulting firm.
“We think those numbers will go up over time and become a standard feature of company plans, but it will take time,” she says. “Employers are worried about adding more complexity to the choices employees face–people have enough trouble making decisions among the options they already have.”
Conversion. One way to get into a Roth IRA is to convert some portion of a traditional IRA to a Roth. Currently, you can’t do conversions if your adjusted gross income is higher than $100,000–but that limit will be removed starting in 2010. You’d be taxed at your top income-tax rate, but you can break up the tax bill payments into installments paid in 2011 and 2012.
“We expect an onslaught of conversions starting in 2010,” says Fidelity’s Hunter.
Resources
IRS information about Roth IRAs
