Ignore the Roth IRA At Your Own Peril
Main Idea: The Roth IRA might be the best way to secure your future, giving you control over your assets and breaking Congress’s long-term attachment to your wallet.
In 1998, the government introduced the Roth IRA, a groundbreaking move named after Senator William Roth.
Surprisingly, this was a win-win for both Congress and the public. Strange, right?
Here’s why: Congress got their immediate tax hit (because Roth contributions are made with after-tax money), and we got the long-term benefit of never paying taxes on that money again—ever.
But here’s the kicker: Congress is a lousy business partner
Imagine someone offers you a business partnership, but there’s a catch—they get to decide how much of the profits they take and when.
This is essentially how Traditional IRAs and 401(k)s work.
You trust Congress to tax you fairly when you withdraw funds, but their rules can change at any time.
With the Roth IRA, you take that uncertainty out of the equation by paying taxes upfront and keeping every dollar you earn in retirement.
The takeaway? Avoid trusting Congress to “do the right thing” with your retirement money.
Roth IRAs put you in control.
What's the Difference Between a Roth IRA and a 401(k) or Traditional IRA?
Let’s start by clarifying something: "Roth" is not an account type; it’s a way the government taxes an account.
There are Roth IRAs, Roth 401(k)s, Roth 403(b)'s, and other Roth options.
Main piece: they're all tax-free upon withdrawal if handled properly.
Traditional IRA:
A Traditional IRA works like a flipped version of a Roth IRA. Instead of enjoying tax benefits later, you get them upfront.
You make contributions, potentially deduct them from your current taxes, and let the money grow tax-deferred. However, withdrawals in retirement are taxed as regular income.
I say "potentially deduct", because like participation in a Roth IRA, taking a deduction with your IRA contribution depends on your current income.
401(k):
A 401(k) is offered through your employer or, if you’re a business owner, via a Solo 401(k).
It has higher contribution limits than an IRA but follows similar tax rules: contributions may be tax-deductible now, but withdrawals are taxed in retirement once you’re over 59½.
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401(k)'s are one of the most popular choices for retirement savings, as many people max out their contributions and forget about them.
Roth IRA:
Contributions to a Roth IRA come from money you’ve already paid taxes on.
Whether through a direct contribution or a conversion, this "after-tax" funding means the government no longer taxes what grows inside the account or is withdrawn (as long as you follow qualified distribution rules).
I’ll dive deeper into conversions tomorrow, but let’s touch on another key difference between Roth and Traditional accounts: RMDs.
Right. What Are RMDs?
Required Minimum Distributions (RMDs) are the government’s way of ensuring they eventually collect taxes on your 401(k) or IRA.
Once you hit a certain age (currently 73), you’re required to withdraw a specific amount from these accounts annually, which can trigger a hefty tax bill.
Like I said...they're a nasty business partner.
With recent changes in tax law, your heirs will have to take distributions from your Roth IRA over a period of 10 years, but it will still remain non-taxable.
Compare this to the other two accounts in which they must do the same in 10 years, except this time it's all taxed.
More on this tomorrow as well.
Key Takeaways for Today:
- Tax-Free Distributions: Roth IRAs provide tax-free withdrawals in retirement.
- No RMDs: Unlike Traditional IRAs and 401(k)s, Roth IRAs are not subject to RMDs, even when you reach age 73 (or whatever the RMD age is by then).
Follow Up: Click here to see if you can contribute to a Roth IRA. If not, there are other options. Please keep in mind you can contribute for 2024 up until April 15 of 2025. Click here to watch a 5-minute video by one of my favorite tax experts on the Roth IRA.
Action Item: Consider opening a Roth IRA today by reaching out to your financial advisor if you have one, or by opening one at wherever you custody your assets.
My name is Jordan McFarland and I'm a CERTIFIED FINANCIAL PLANNER™ at SageSpring Wealth Partners in Dallas, TX.
My goal with these brief articles is not to make you an expert, but get you thinking about ways you can optimize your finances and get ahead for tomorrow.
If any questions or thoughts come up during your reading, you can email me at jordan.mcfarland@sagespring.com.
Unfortunately, I must keep these articles rather vanilla and short in order that I do not trip any compliance wires. I'd be happy to meet with you to hear about your specific goals when the time comes.
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