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No Deduction Up-front; No Taxation at the Back

It was once called, “A gift from Uncle Sam.” This type of tax shelter, the Roth IRA, is not only an effective way to save for retirement, it is “one of the smartest money moves a young person can make,” according to Kiplinger.

More flexible than a conventional IRA, a Roth won’t get you the same up-front tax break because you are using after-tax dollars,not pre-tax dollars, for your contributions. You pay taxes on the money you put in the account. If there is a downside to a Roth IRA, and there aren’t many to speak of, some people say this is it.

Roth and conventional IRAs frequently get mixed up, so the best way is to think of a Roth as having backloaded tax benefits, while a conventional IRA has frontloaded tax benefits.

It’s Fairly Simple

You can contribute to a Roth IRA if you have earned income and meet the income limits. By linking your checking account you can have the deposits automatically e-transferred.

But this isn’t to say you are limited to a conventional job for income either. If you have income from other sources that qualifies as “earned,” like investment income from securities, rental property or other assets, you can contribute. In fact, spouses with no income can contribute to a spousal [Roth] IRA using the their spouse’s earned income.

A single person with a Modified Adjusted Gross Income (MAGI) under $140,000 for the tax year 2021 can contribute to a Roth IRA. A married person filing jointly, with a MAGI under $208,000 for the tax year 2021 can also contribute. You have until April 15, 2022 to make contributions toward your 2021 IRA.

By using a Roth IRA, you can likely avoid a “tax headache” later in life and can keep more of your retirement income and Social Security income away from the IRS.

If You Don’t Need the Money Just Yet

Owning a Roth IRA for 5 years, allows all withdrawals after age 59½ to be taken tax-free. In addition, if a person is disabled or dies before age 59½, any previous distributions are without the 10% early withdrawal penalty.

As a result of COVID-19, anyone who had tested positive in 2020 can take up to $100,000 out of a Roth IRA or other retirement accounts and the early withdrawal penalty is waived.

Distributions prior to age 59½ are without the penalty tax, but with regular tax due, on such qualifying higher education expenses as tuition, room, board and books ­­– as is the first $10,000 of a first-time home purchase expense.

Having a Roth IRA means not having to take mandatory distributions at age 72 either – like a traditional IRA – and you are permitted to make contributions even after age 72. With the proposed SECURE Act 2, not yet finalized, you will be allowed to save longer by increasing your required minimum distributions to begin at age 75.

If you have taken on a second career after retiring from your primary career, and you don’t need to touch your retirement savings, leave it alone and keep it invested. When the time comes to start taking withdrawals, whether systematic or otherwise, you can then do it tax-free.

Fair Comparisons

In many cases, experts say a Roth IRA can be a better choice than a 401(k) retirement plan, because it offers a flexible investment vehicle with greater tax benefits—especially if you think you’ll be in a higher tax bracket later on.

By now, most people know how 401(k) retirement plans work. As an employee, you contribute pre-tax dollars and can choose from a variety of investment options and packaged portfolios especially if you think you’ll be in a lower tax bracket later on.

You can also choose target date funds too, where the asset allocation is designed to gradually shift to a more conservative profile to minimize your risk when your target date, the year in which retire and begin utilizing the assets, approaches. Your contributions, including your employers’ match and all of your earnings, grow tax-deferred. Whenthey are withdrawn in retirement they are taxed.

With a Roth 401(k), similar to a Roth IRA, you make your contributions with money that has already been taxed when you put it in. After all, you don’t know what your taxes will be like in the future. Your earnings grow tax-free, and you pay no taxes when you start taking withdrawals in retirement.

If you withdraw money from a traditional 401(k) plan before you turn 59½, you pay taxes and potentially a 10% penalty on the entire withdrawal.

With a Roth 401(k), you can withdraw your contributions tax- and penalty-free, except if the distribution is not a qualified distribution. The earnings are taxable and subject to the 10% penalty.

If you roll over your Roth 401(k) into a Roth IRA when you retire, your assets can continue to grow tax-free and can be passed along to your heirs. Your Roth IRA has no RMDs.

Take control of your financial future. Our MASTERPLAN® approach puts you on track to meet your goals. If you have questions, or would like more information on anything we mentioned here, please contact us at Hefren-Tillotson today. We would be happy to help.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.

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