Roth IRA

Reduce your taxes at retirement

The U.S. Congress created the Roth IRA in 1997 to help individuals save for retirement. While the traditional IRA provides tax deductibility on contributions made (as well as deferring taxes on earnings growth while in the IRA), once you start mandatory withdrawals at age 70½, you do pay taxes on every dollar taken out from that point on. On the other hand, the Roth IRA uses after-tax dollars for contributions, so any funds you withdraw after age 59½ will be tax-free. You won't pay a cent.

The contribution levels in 2007 are the same as for the traditional IRA: $4,000 for those under 50 and $5,000 over 50. Contributions can be made after age 70½ and can be left in the plan indefinitely. However, if you are an individual earning more than $110,000 or a couple making more than $160,000, you won't be able to contribute.

Roth IRAs are the perfect retirement account for young people. By putting away a little each year and letting it grow tax-free, you are paving the way to a wonderful retirement. Better to pay the taxes now than in the future. The traditional IRA is only tax-deferred whereas the Roth IRA is tax-free. The Roth IRA, combined with a 401k, provides better flexibility when dealing with retirement tax issues. By having a combination of withdrawals at age 70½, you could minimize mandatory taxable withdrawals and cover your remaining financial needs with tax-free withdrawals from the Roth IRA. Further, should you need emergency funds after age 59½, you could take those from your Roth IRA without having to pay any tax.

The problem is that the average person may have trouble budgeting for both a 401k and Roth IRA contribution. Life isn't cheap. With every decision to invest, another becomes where to cut money from the budget to pay for those investments. Most people are only a paycheck away from financial hardship. Making tough choices is what financial planning is all about.

If your budget will only accommodate one retirement vehicle, the clear choice is the 401k. Take advantage of your employer's matching contribution up to the maximum and then if you have any funds left over, put those into a Roth IRA. Doing so will balance your taxable and tax-free withdrawals at retirement.

Financial planning doesn't happen in a vacuum. Every person's situation will be slightly different, but the goal for all should be the same. Take advantage of every opportunity to save for your retirement. Whether in a Roth IRA or a traditional IRA, maximizing your $4,000 contribution limit makes absolute sense. It should be a priority.

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