Concerned he might not be ableto save enough for retirement through his 401(k), Russ Munisteridecided to open a Roth individual retirement account two years ago.
The North Bellmore, N.Y., resident was particularly interestedin the Roth individual retirement account because, unlike with histraditional 401(k), he will not have to pay taxes on the IRAwithdrawals at retirement. (Of course, he doesn't get to deduct hisannual contributions to the Roth IRA on his taxes, as he can with histraditional 401(k).)
Munisteri, a computer network administrator in Uniondale,N.Y., already has pumped nearly $6,000 into the account and adds moreeach month. "If I save all this money, it's mine," said Munisteri, whoconvinced his girlfriend to open a Roth IRA as well. "That's the mainattraction. What I see in the account is mine. I don't have to worryabout paying the government at 60 years of age."
Roth IRAs, as well as the newer Roth 401(k)s, are a smart betfor many younger people, experts say. Younger workers are more likelyto be in a lower tax bracket now than when they retire, making anycurrent tax deductions less valuable, and they have enough years tosave to make the tax-free withdrawals very beneficial.
The beauty of the Roth IRA and 401(k) is that there's no taxon the capital gains in the accounts, so the longer you have toaccumulate those gains, the better.
"For young people, it just doesn't pay to get a deductionnow," said Rockville Centre financial adviser Ed Slott, author of Your Complete RetirementPlanning Road Map (Random House, 2006). The lack of adeduction "will pay for itself many times over by building a retirementaccount that will be tax-free forever."As you near retirement, you need to consider what your taxbracket is likely to be when you stop working and whether it makes moresense to get a deduction now by contributing to traditional accounts.Also, consider that tax rates are at all-time lows, and many expertsthink they will rise in coming years. So you may be better off payingthe taxes now than in the future.Some people may not be familiar with Roth versions of the IRAand 401(k) because they haven't been around as long as theirtraditional counterparts. The Roth IRA became available in 1998, andthe Roth 401(k) debuted last year.They are, however, growing in popularity. Roth IRAs held $145billion in assets in 2005, up from $78 billion three years earlier,according to the Investment Company Institute, a trade group for themutual fund industry.Some 12 percent of companies offered a Roth 401(k) last year,and another 32 percent are very or somewhat likely to implement it thisyear, according to Hewitt Associates, a consulting group.
How they differSo what exactly is the difference between a Roth IRA and401(k) and a traditional IRA and 401(k)?Clearly, the main one involves taxes. With traditionalaccounts, you can get an upfront tax deduction on your contributions,but you have to pay income taxes upon withdrawing the money atretirement. With the Roth versions, you get no upfront deduction, butthe money accumulates tax-free, so you pay nothing on the capital gains.Melanie Theisen of Rocky Point used to be more interested ingetting deductions when she worked as a freelance mortgage processorbecause her employer did not take out income taxes, and she wanted toreduce her tax liability in April. So she contributed to a traditionalIRA.Nowadays, she is more focused on the future, so she's thinkingabout a Roth IRA. "I don't need the deductions now," said Theisen, anoffice manager for a nonprofit group in Upton. "Now, I'm worried aboutgetting taxed when I take the money out. I'm figuring taxes only go oneway ... up."While Roth and traditional 401(k)s differ mainly in taxtreatment, many of the other rules are the same: You can contribute upto $15,500 this year, and those 50 and older can add another $5,000,for instance.Explaining IRAsBut their IRA counterparts are more complex.
If you do not have a retirement plan at work, you can deductyour contributions to a traditional IRA no matter what you earn. But ifyou have a pension or 401(k), deductibility starts to phase out if youradjusted gross income is more than $52,000 if you are single and$83,000 if married this year. You cannot deduct your contributions ifyou earn more than $62,000 if single, and $103,000 if married.If you do not have a retirement plan but your spouse does, thephase-out ranges from $156,000 to $166,000.For Roth IRAs, your ability to contribute this year phases outif your adjusted gross income is more than $99,000 if single and$156,000 if married. You cannot contribute if you earn more than$114,000 if single and $166,000 if married.You can put in up to $4,000 in either a traditional or RothIRA depending on your income. Those who are age 50 and older cancontribute an additional $1,000. And you have until April 17 to makeyour contributions for 2006, which had slightly lower income thresholds.Another plus for the Roth IRA is that account owners canwithdraw their contributions at any time for any reason with nopenalty. Withdrawals from traditional IRAs are limited to highereducation, first home purchases, and certain medical and long-termunemployment expenses.
Those who have a traditional IRA may want to convert it into aRoth. But since you will have to pay the taxes on your contributions upfront, you should consider it only if you have enough savings outsidethe IRA to pay the Internal Revenue Service, said Rande Spiegelman,vice president for financial planning at Charles Schwab.Then, you can turn to the Internet and calculate what yourlikely balances would be in retirement if you kept the traditional IRAor if you converted to a Roth. Most major mutual fund companies, suchas Fidelity and Vanguard, have online tools to help you decide.Right now, your adjusted gross income must be less than$100,000, whether married or single, to be eligible to convert. Butthat limit disappears in 2010, when you will also have two years to paythe taxes due on the conversion.If you aren't sure whether to contribute to the Roth ortraditional versions of the IRA and 401(k), you could always fund both.For instance, you could put money into a traditional 401(k) at work andthen contribute to a Roth IRA."You can hedge a little by splitting it up," said John Knapp,vice president at Fidelity Investments. The Roth IRA or 401(k)may be for you if: You think you will be in a higher tax bracket inretirement. You think tax rates may rise in the future. You have many years until retirement for the account toaccumulate capital gains tax-free. You don't want to worry about paying taxes on withdrawalsfrom the account in retirement and are willing to forgo the taxdeductions you get now from traditional accounts. You want to save for retirement but are concerned aboutnot being able to access your contributions during your working yearswithout a penalty. You want to save more money for retirement in an IRA, butmake too much to qualify for a traditional IRA.Roth's appeal
Twelve percent ofcompanies in the UnitedStates already offer Roth 401(k)s. Among those that don't, one-thirdare at least considering offering them this year.Likelihood of offering Roth 401(k)s in 2007: Very likely 11 percent Somewhat likely 21 percent Somewhat unlikely 33 percent Very unlikely 35 percentYounger investmentWorkers younger than 30are choosing Roth 401(k)s. Percentage electing Roth 401(k)s when theywere available: 20 to 29 13.7 30 to 39 8.1 40 to 49 5.0 50 to 59 4.1 60 to older 3.1Source: Hewitt AssociatesSource: Newsday. Poweredby Yellowbrix.
Source: Money & Work
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