Who Needs a Roth IRA? Maybe You Do

Investing

This submission is part of the NerdWallet 2013 Roth IRA writing contest. The views and recommendations presented in this piece are held by the individual contest participant and do not represent those of NerdWallet.

 

by Crystal Spraggins

In the industry I’m known as a “reluctant saver.” Intellectually, I know I should save for retirement, because I don’t plan to work forever. I also know that unforeseen events can threaten financial stability if certain preparations aren’t in place and that there are tax benefits to participating in a retirement plan. And because I know these things intellectually, I save.

But I’d rather not.

And it doesn’t help that there are so many retirement plan options. As I said, I’m not an investor, I’m a saver, and a reluctant one at that.

But I do have one ace up my sleeve. I’m an HR professional, and I’ve managed retirement plans for years. And one thing that no one in my position could fail to learn is the importance of a diversified portfolio.

A New Definition of Diversity

Just like in the old days when “diversity” training mostly referred to relationships between blacks and whites but now means much more, the term “diversified portfolio” is no longer limited to refer to your mix of mutual funds, stocks, bonds, and cash. Instead, if you’re looking to have a diversified portfolio, you’ll want to think about the types of retirement plans available. So if you have access to an employer-sponsored 401k or 403B plan, you should definitely take advantage, but there also are good reasons to investigate options available outside of work, including the traditional IRA and the Roth IRA.

What’s a Roth IRA?

Under a traditional IRA, contributions are made on a before-tax basis and taxes are not paid until monies are withdrawn. Under a Roth IRA, contributions are made on an after-tax basis, and so withdrawals are tax tree.

My experience is that most people understand how a traditional IRA works, but many are confused or lack appreciation for how a Roth works or what the advantages may be. This confusion is not that surprising, really. The Roth is a newer product, many employers don’t offer it (and because most of us get our investment information from our employers we lack a frame of reference to discuss Roth products elsewhere), and ours is a culture that promotes immediate gratification—even in the context of retirement savings!

Why a Roth IRA?

So let’s ask the question. Why save money on an after-tax basis and only reap the benefits at some future point when you’ll probably be in a lower tax bracket anyway?

And, that brings us back to diversity.

During your retirement, there may be periods when it’s beneficial for you to be able to withdraw cash on which you’ve already paid taxes. That’s when a Roth can come in handy, even if you have other monies saved in traditional plans. Maybe you receive an inheritance that year, or maybe you sell a house or a business that year. Also, before making a blanket determination that you’ll be in a lower tax bracket in retirement, you may want to do the math.

But that’s not all. A Roth IRA offers benefits in the here and now, too. You won’t be penalized for early withdrawals should you need to access your money in a pinch, provided the money has been in the account for at least five years and you’re at least 59 ½ years old at the time of the withdrawal. (Before five years and after age 59 ½ you’ll pay a penalty on earnings.) Money saved in a Roth is not subject to mandatory minimum distribution regulations once you reach age 70 ½, and this is becoming increasingly important as the population ages. Finally, money left for your heirs from a Roth account may not be subject to taxes.

Not for Everyone But Definitely Good For Many

A Roth IRA is not for everyone, but it’s definitely good for some. I encouraged my teenage son to join a Roth because his income was minimal and so was his tax liability. Better for him to pay taxes now instead of later. As his income increases, he can elect to participate in a traditional IRA as well, if that makes sense for him.

Before making any investment decision it’s important to read the fine print and understand the rules, such as eligibility, contribution limits, and penalties for early withdrawals.