What the Heck is a Roth IRA and Why Do I Need One? – Financially Fit Mama

What the Heck is a Roth IRA and Why Do I Need One?

The basics of the Roth IRA as an important retirement savings vehicle
When I worked at the bank, I noticed an interesting thing. As soon as I would start to talk about retirement savings, people’s eyes  would begin to glaze over like it was just too much for them.

I don’t know whether retirement seemed too far away to care much about or whether it felt too complicated for most people.

What I do know is that it is sooooo important that you have a good retirement savings strategy. So, stay with me here.

I’m going to break down one retirement savings vehicle – the Roth IRA – into what it is and why you need it.

What is a Roth IRA?

A Roth IRA is a retirement plan. See? That wasn’t so hard. Okay, there’s a little more to it.

The Roth IRA was named after Senator William Roth, from Delaware, who was one of the main proponents of a law to allow people to create accounts where you are not taxed when you withdraw the money during retirement.

So, the Roth IRA is an account, usually made up of mutual funds (but doesn’t have to be), that you start with after-tax dollars.

Why Do I Need a Roth IRA?

The idea behind a Roth IRA is that you will save money because your tax bracket when you pay into it will be lower than your tax bracket when you begin to draw from it during retirement.

Let’s take Michelle as an example. Michelle is a 28-year-old mom of two who listens to my advice and runs to her nearest bank branch to open a Roth IRA.

She works full time and makes $36,000 a year, before taxes, as an executive assistant. Michelle is in the 15% tax bracket.

Michelle works her way up to being a Director of Operations and when she is ready to retire, she is making $68,000. Now, Michelle is in the 25% tax bracket.

She and her husband have become accustomed to living in their current income range and would like to continue to live with a similar income during retirement.

Because Michelle already paid taxes on her Roth IRA when she paid into it, her withdrawals now are tax-free. Instead of paying 25% taxes when she withdraws (as she would with a traditional IRA or 401k retirement plan), she can now withdraw the money tax-free.

So, Michelle is a great candidate for the Roth IRA because she will save money in taxes and all of the money in her IRA will go in her pocket.

More Benefits of the Roth IRA

The tax advantage is the biggest benefit of the Roth IRA, but there are a few others.

1.You don’t have to take withdrawals at any age.

This is very different than a traditional IRA, where you don’t pay taxes when you invest the money, but pay taxes when you begin to withdraw.  You are required to begin to withdraw the money at age 70 1/2.

2. You can keep contributing to a Roth IRA forever.

Just like the withdrawal rule, with a traditional IRA you can’t contribute to  it anymore after age 70 1/2.

3. There is more flexibility than other retirement accounts.

With the traditional IRA, you will be penalized for any early withdrawal (before age 59 1/2) that you need to take for an emergency, but with a Roth IRA, any money that you have put in will not be penalized.  There are exceptions that will allow you to avoid the tax penalty, like a first-time home purchase, but for the sake of simplicity, let’s just leave it as this is another advantage of a Roth IRA.

Who Can Open a Roth IRA?

Now you want one, right?  Let’s see if you qualify for a Roth IRA. You need:

  • A taxable income.  If you don’t have any taxable income, you can’t open a Roth IRA.
  • Make less than $133,000 if you are a single filer. If you make more than $133,000, you cannot open or fund a Roth IRA. (A phase-out also starts at $118,00, so check with a tax adviser if you fall in this range.)
  • Make less than $196,000 if you are filing jointly. If you and your spouse make more than $196,000 combined, you will be ineligible as well. (A phase-out starts at $186,000, so check with a tax adviser if you fall in this range.)
  • Fund with a maximum of $5,500 per year ($6,500 if you are over 50).  If you are looking to invest large amounts of money for retirement, you will only be able to put up to $5,500 in a Roth IRA per year or $6,500 if you are over 50.

There is so much more information available about the Roth IRA and other retirement savings options.  If you are interested and want more information, I suggest checking out the government’s  retirement savings site.

And always talk with a trusted financial adviser to make your retirement and savings plans.

Happy retirement saving!

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