Why do I need a Roth IRA?


Roth IRA

What is a Roth IRA?

A Roth IRA, or Roth Individual Retirement Account is a specialized retirement investment account created by congress in 1989. It allows you to contribute “after tax” dollars to invest in the stock market, which become eligible for withdraw penalty free on the principal at any time.

Only Wages and “Earned Income” Are Eligible

The IRS stipulates you can only contribute “earned income” to a Roth, such as salary, wages, tips, or bonuses. You are not allowed to contribute interest or dividends from investments, retirement income from IRAs or Pensions, Social Security Benefits, Unemployment, alimony, or child support.

An advantage to the Roth is you can withdraw gains after 5 years penalty and tax free. This feature lowers your effective tax rate and allows your money to compound at a faster rate.
The annual contribution limit is $6,000 a person in 2019, with an extra $1,000 for a “catch up” contribution for people aged 50 or older. For a married couple, each individual can contribute $6,000 to a Roth allowing the combined contribution to reach $12,000 for 2019.

The biggest advantage for the Roth occurs in retirement, when you take a distribution from your Roth IRA it does not add to your adjusted gross income; whereas a traditional IRA account does add to your adjusted gross income. There is no required minimum distribution, meaning you are under no obligation to withdraw your retirement fund when you reach age 70 and 1/2, whereas you are required withdraw funds in a traditional IRA and 401k when you reach this age.

Use Interactive Brokers to open a new Roth account

When opening a Roth account, you need to be careful choosing your broker because not all are created equal. We work with Interactive Brokers because their Roth Account trades most similar to a traditional cash brokerage, whereas other brokers severely limit your trading privileges by disallowing options trading and other advanced investment strategies. A Roth Account with Interactive Brokers has tremendous investment flexibility allowing you to choose individual stocks, ETFs, Bonds, Options and sometimes forex. You can build a tailored portfolio of your choosing and in some regards the account trades very similar to a traditional brokerage account (less having margin trading ability). With an Interactive Brokers Roth, you can create advanced investment strategies incorporating hedging, while maintaining the advantages of a retirement account. The Roth is better than a traditional 401k because the 401k only allows you to invest in the plan sponsor investment options such as target date funds, which normally provide very few investment choices.

Some Disadvantages

A disadvantage is you can’t take a loan out against your Roth as collateral. This Roth feature loses to a traditional 401k because when you reach retirement age with a 401k, you can elect to take a low interest loan against your funds at a low tax liability. With a 401k, the plan sponsor may offer a low interest rate loan against your 401k as collateral, which is similar to a home equity loan with your 401k acting as insurance in case you default on the loan.

Another disadvantage is if you file taxes as married filing jointly or a qualifying widower and earn over $203,000 in Adjusted Gross Income you are not eligible to contribute to a Roth IRA. The Roth has income limits to help the working save for retirement and reduce their tax burden, while limiting affluent investors from using the account as a tax shield.

Some 401k plans offer a Roth account, that is different than a normal Roth

One less talked about aspect of a Roth, is a 401k Roth account. This account is normally offered within your traditional 401k employer sponsored plan and it has few differences than a normal Roth. The biggest advantage is the contribution limit to the 401k Roth is the same as your entire 401k limit, $19,000 in 2019. You could have a regular Roth IRA and a 401k Roth IRA and potentially contribute $25,000 annually to your retirement accounts, assuming your employer offers the Roth 401 option.

Not to mention, these contributions can be eligible for employer match, meaning your employer can choose to go dollar for dollar on your retirement. Again, this depends on whether your employer offers this option, a large company that employs a few of my clients offer a 50% match up to 8% of their salary. This means if my client makes $100,000 a year and they decide to contribute $8,000 to their 401k, the employer will contribute 50% of $8,000 or $4,000 to the employees 401k plan. This is effectively free money and employees lucky enough to have a 401k match should always maximize their contributions up to the limit the employer would match. The reason for this is if you were walking down the street and saw $20 dollars laying on the ground, would you walk past and not pick it up? The answer is no because you never pass up free money.

Thinking about opening a Roth Account?

Learn more about how we manage client Roth accounts in our firm
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