The Roth IRA is a special type of retirement account that makes it possible to avoid taxation on investment returns because you invest with money that you have already paid taxes on in the present. If you are trying to decide what type of retirement accounts open, the Roth IRA has some specific advantages that you need to be aware of. Here are a few things to consider about when to open a Roth IRA.
Expect Tax Brackets to Increase
You should consider opening a Roth IRA if you expect your tax bracket increase over time. For example, if you are in a lower-wage job now, but you expect to move up the corporate ladder and start making more money when you get older, it makes sense to participate in a Roth IRA now. Since the Roth IRA is funded with after-tax money, it makes sense to pay taxes on the money when you are in a lower tax bracket. This way, when you get to retirement, you won't have to worry about paying taxes on the money that you take out of the Roth IRA at a higher rate.
This about this: you make $40,000 per year, so you are in the 25% tax bracket, but your effective tax rate is closer to 15%. You can invest your money now into a Roth IRA, and when you withdraw it in retirement, you pay no tax. Long term capital gains taxes are currently 15%, so you would break even, but they will most likely rise in the future.
Government Tax Increases
You may also want to consider opening a Roth IRA when you are leery of the possibility of increased tax rates in the future. If you have paid any attention to the economy lately, you know that the national debt is spiraling out of control. At some point, the government is going to have to get serious about paying the debt down. Besides making big spending cuts, the government will also have to raise taxes. In the future, tax rates may be much higher than what they are now. If you can get your taxes out of the way now, you won't have to worry about that later on when tax rates are higher.
Right now, taxes are at all time historical lows. The odds are against them remaining there for the next 20 to 30 years.
If you expect your income to go up by a lot at some point in the future, you may want to get some money set aside in a Roth IRA now. The Roth IRA has income limits on who can put money into the account. If you make more than $110,000 as an individual, you will not be able to make a full contribution. If you make less than that now, it makes sense to go ahead and open an account so that you can get some money built up.
Overall, the Roth IRA is a powerful type of retirement account that lets you take advantage of tax benefits. For most people, it makes sense to get started with a Roth IRA sooner rather than later.
Do you invest in a Roth IRA?