Just starting out and considering Roth IRAs

[Guest jaeyoung]

I am 27 and single. My current income is $46,000. My current job does not have a 401(k) or pension program. I have been reading up on ROTH IRAs and I think I would like to start one, hopefully in time for the 2005 contribution deadline. I don't have any experience in investing. I have enough set aside right now to make the max contribution and I could probably continue making the maximum contribution each year. Any advice would be much appreciated.

The other question I have is regarding the cap on contributions. I've seen that you can only make contributions if you are single and earning $95,000 or if you are married and your joint income is $150,000. When you earn beyond that cap, can you still continue to invest the IRA? And will the earnings continue to be non-taxable? I'm not sure where I will be in the future and I have the potential to earn over the $95,000 in the next 5-10 years, so I am curious.

[txdd]

Whether it's good to put money into a Roth IRA depends on your personal situation. There is no blanket answer.

The 95000/150000 income limits are actually where your Roth contribution becomes limited. Some Roth contrtibution is allowable up to modified adjusted gross incomes of 110000/160000.

If you are ineligible for Roth contribution in any year (All years are treated independently.), your Roth account goes on with the same status (investments, taxes, earnings, etc.). You just can't add new money to it.

[Guest redlenses]

In 5-10 years hopefully they raise the caps based on inflation - but you can never count on the government to make common sense decisions - look at how long the IRA contribution was stuck at $2000

If you get partially phased out (make over $95,000/150,000) or fully phased out (make over $110,000/160,000) you can still make a non-deductible Traditional IRA contribution for the difference of $4000 - your Roth contribution.

If your income falls below $100,000 for any year after these non-deductible contibutions have been made, you can do a Roth Conversion and will not be taxed on the origional contribution amounts (assuming you convert all Traditional IRAs to Roth IRAs).

If you start making income up around the phase out range, hopefully it will be with a company that offers a 401(k) and matching. A 401(k) offers huge advantages towards saving for retirement - mainly the high contibution limits.

Generic advice I often hear is: 1) Fund 401(k) to level that gets you all of your company match (free money). 2) Max out your Roth IRA, 3) Max out the rest of your 401(k).

That advice probably changes if the Roth 401(k) is available.

Take advantage of all Free money available and plan for Taxes that will be in effect when you retire.

Free money = money that your company gives you and money that goes into your retirement instead of towards taxes.

Taxes: If you think your taxes will be higher in retirement than they are now and if you think your earnings will be substantial then the Roth is wonderful. Earnings are Tax Free in a Roth.

If you think taxes will remain the same and that you will be in a lower bracket in retirement, then Traditional 401(k) and Traditional IRAs may be a good idea. All distributions are taxed so you do pay taxes on earnings eventually.

Keep in mind that if our country decides to actually pay for goverment programs (Social Secuirty, Medicare, Defense, Social Programs, etc) in the future instead of running deficits and issuing debt, taxes may skyrocket and your lower tax bracket in retirement may have a higher tax rate than your current tax bracket today.

Diversifying (having both pre-tax and roth-type plans) may be a good idea since guessing wrong could be costly.

[John G]

I think putting 4K into a Roth each year is a good start. Worry about future eligibility and future max amounts in future years... sounds like that you are just fine for 5+ years. What you start now can continue into the future even if your eligibility changes.

What does 4K a year for the next 40 years get you? Nearly 2 million in 2046 if your investments average 10% per year - which would reflect a long term commitment to mutual funds invested in stocks (equities) with just a slight bias towards growth. That number would go higher if the limits move up or you get a better return. That 2M does not include home equity, social security, pensions, any other retirement program, your spouses assets or other taxable investments. Note, that's 2 million in nominal 2046 dollars, but even if you factor out 3% inflation the current year purchasing power would be around 600,000.

You have one week left to get your 2005 contributions into a Roth account! Don't procrastinate.