A growing number of people are hopping on the Roth bandwagon. Although traditional IRAs hold about 10 times the assets that Roth IRAs do, Roths are growing much faster. Charles Schwab says that the number of Roth accounts on its brokerage platform have risen 32% in the past five years.
As you’ll recall, traditional IRAs and 401(k) plans are funded with pre-tax dollars, and investors eventually pay taxes when holdings are sold. The proceeds are taxed at ordinary income rates, which can lead to a hefty tax bite if a retiree already is drawing Social Security, a pension, or other forms of income. Roth IRAs and Roth 401(k)s are the opposite. They are funded with after-tax dollars, which means you’ll pay their taxes now, and not later.
For anyone that is in a lower tax bracket now than will be expected in the future, a Roth IRA (or Roth 401(k)) makes ample sense. That means that such plans hold great appeal to young savers that are not yet near their peak earnings years.
And converting an existing retirement accounting to Roth-style account (known as a “Roth Conversion”) makes ample sense for other workers. Anyone that is experiencing a temporary earnings dip during career transitions or has retired but is not yet collecting Social Security or taking Required Minimum Distributions (RMDs) from a non-Roth retirement account should take advantage of their current lower tax bracket.
There’s one more key difference between Roth accounts and their pre-tax counterparts. Unlike with traditional IRAs, the ability to contribute to a Roth doesn’t end when a worker reaches 70½.
We’re talking about yearly changes In our tax brackets and it can be a challenge to accurately determine what your tax rates will be in the future. Your income picture may deviate from what you currently expect. And you can count on Congress to constantly change “the rules of the road” when it comes to retirement plan laws.
According to benefits firms and retirement-plan sponsors, more employers now offer Roth 401(k)s that allow workers to put in all or a portion of their retirement savings. The current max annual contribution to a Roth 401(k) is $16,500 for 2014 (plus another $6,000 for those 50 and older). Roth IRAs have a $5,550 limit with a $1,000 catch-up addition for those over 50).
The deadline for putting money into 401(k) plans is generally Dec. 31, but savers can contribute to traditional and Roth IRAs by April 15 of the following year. As we head into the final stretch of the year, this is a good time to figure out whether a Roth IRA makes sense for you.