Apr 8th, 2008
$4,000 Now, Nothing Later: the Beauty of the Roth IRA
I wrote a $4,000 check this week. That hurt, but it’ll end up helping in the end. You see, the $4,000 was bound for my Roth IRA–my 2007 contribution.
There are very few investment accounts I think of more highly than the Roth IRA. While the traditional IRA is available to more people and for some allows pre-tax dollars to be invested, it requires mandatory withdrawals at age 70 1/2 and withdrawals are taxed at ordinary income, the Roth IRA allows the investment of post-tax dollars (but for many, including myself, even traditional IRAs can only be filled with post-tax dollars due to the regulations around income and retirement plans) but allows withdrawals tax free provided the rules are followed.
Yes, it can be argued that for some (if not many or most), the traditional IRA may end up being a better retirement deal–it all depends on what tax brackets are in place now and at the time you need the money, and for those who earn too much to contribute to a Roth IRA, then the traditional is about your only choice. However, if you don’t get a tax break now with your up front dollars, there’s no question that a Roth is a better deal. And if you think that you’re going to do well enough with your other accounts that you won’t need to withdraw from your IRA until past age 71, then a Roth is really what you want as it doesn’t require withdrawals at a certain age.
So while I don’t write checks in the amount of four grand often, and it pains me to do so, this is one of those “no pain, no gain” situations. What I’m counting on is that thirty years from now, if I’ve played my cards right, I won’t need to withdraw the money in my Roth IRA, but if I do, I can do so without worrying about being taxed. That would be a great gift in retirement!
I think Roths are pretty exciting!
At this stage, we’re in a low low tax bracket anyway so we’re not paying as much in taxes on our income as we might if we went up even one level.
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I like the idea of the Roth IRA, but there’s one great flaw (at least in my opinion): as far as I know (and please correct me if I’m wrong about this), there’s a 10% penalty for withdrawing the money early, “early” being before you’re 59.5 years old.
While this may not be such a big deal for all the people who plan to work till they drop, retire at 60 and travel the world with a walker/cane/wheelchair/what-have-you and a suitcase full of pills and medicines, there are those of us who are planning to retire at a younger age (35-40). In that case, Roth IRA would be rather useless…
GL:
The comparison I make is a Roth IRA vs. a traditional IRA. In that case, they -both- have the same disadvantage. Good luck on retiring that early, but the vast majority of Americans don’t (and even if I had enough money to, I’d still work because I do the kind of work I’m born to do).
That said, there’s lots of ways to have great savings plans that aren’t tax advantaged without such a penalty. I have both. If I do fantastically well and can start living off investments really really early, then fine, I’d -still- keep the Roth until I was able to withdraw without penalty at age 59.5. Unless someone’s planning to die before 59.5, it’s still a great deal!
@admin: I agree, but only to a certain extent.
The main problem with life is that nobody ever “plans to die” – it just happens. Statistically speaking, quite a lot of people die before their life expectancy age. And even if you knew for sure that you’d live to be 100, would you spend more time working – until you were, say, 70 – and then retire at an old age, ridden with illness and fatigue? Or would you rather set up a series of mini-retirements (a concept advocated by Tim Ferriss) and enjoy your life while you still can?
GL:
Actually (speaking from my IRL experience as a licensed clinical social worker), there -are- people who plan to die. In this country we generally consider them mentally ill, but there’s the Hemlock Society as well as others who plan out their deaths. There’s also many who, while not planning out their deaths, certainly plan for them with advanced health care directives, wills, and (hopefully term) life insurance.
That said… what makes anyone think 70 is old? Ask a geriatrician (I work with them every day) and they will tell you that 70 is certainly not very old today, and if you take care of yourself you can certainly have a great life with lots of activity. My 74 year old mother has less medication and chronic illness than I do!
To get to the personal finance point, however… if you really do plan to retire at 35 to 40 (and good luck to you to achieve that!), I would suspect that you have too high of an income to qualify for a Roth IRA anyway, and even if not, you’re pouring much more than the limit into investments. That’s great! But what I don’t understand in your argument (assuming that you have more than enough money to put into an IRA–Roth or otherwise–and save tons more in non-tax advantaged accounts for retirement) is this: why have to choose between a retirement and non-retirement account? Why not fund both? I do.
admin:
I’m not exactly planning out my funeral or shopping for a coffin just yet – I’m in my 20s and (so far) in great health. Based on what I’ve seen in my life so far, though, sometimes random things happen. My friend’s relative, for example, led a healthy life, exercised, didn’t smoke, but died of lung cancer. O_o
And of course, with proper care and exercise, a person can still be in great shape by 70. But would that same person be able to dance all night in one of Rio-de-Janeiro’s many carnivals and then enjoy intimacy, so to speak, with a beautiful girl?
My point here is that age has its advantages…
I don’t have the world’s best job and I don’t make much more than my peers. However, I follow the golden rule of spending less than I earn (aka the one-step guide to becoming rich haha), I don’t buy on impulse, I keep my spending to a minimum (while still enjoying life), I use credit cards to my advantage (always pay off the bill in full every month and then reap the reward point benefits), and I invest the rest. Right now is a great time to to invest in stocks, by the way – the prices are low and will eventually rise back to – and beyond – their pre-recession levels.
And as for not using Roth-IRA (which, I believe, started this whole discussion haha) – the main turn-off for me is the fact that you have to wait so long to withdraw the money. I am an entrepreneur and have a few side businesses I run from home. Every now and then, a really great money-making opportunity arises, and I need to liquefy my assets in order to go all in. I’m talking about opportunities that allow your investment to increase double-, triplefold or even more. It’s all perfectly legal and risk-free, but most people never even bother to look for such opportunities, because they’re locked in the mindset of someone who wants to work till they start receiving the social security payments. ;p
GL,
As a guy who actually loves his profession, I don’t see anything inherently awful with wanting to work until I start receiving Social Security payments. I plan to. I’m planning to not need to, but there’s a lot of benefits of work, not the least of which is making a difference in the world (and I am not exactly a fresh out of school idealist; I’ve been in social work for 19 years next month!).
That said, I still don’t see any of what you’re saying precluding the use of a Roth IRA as a great investment vehicle. There are tremendous long term tax advantages to using it, and for some of the issues with age and illness, one of the exceptions to the 10% early withdrawal penalty on all IRAs is to pay medical expenses in excess of 7.5% of your gross salary (I am not a tax professional, check with your tax professional to make sure before doing something rash). However, there is one other situation where you can use (some) of your Roth IRA money before 59 1/2 without the 10% penalty–because you make contributions to the Roth IRA post tax, your contributions (key word: contributions, as in, “not earnings”) may be withdrawn without the 10% penalty. Repeat as above with your tax professional.
Perhaps because I’m older (in social work years, I’m 287), I really don’t see 59 1/2 as “so long”. Someone who is that age is abundantly young and has the possibility to work many, many more years if they choose to!
[...] $4,000 Now, Nothing Later: the Beauty of the Roth IRA – Uncommon Cents I wrote a $4,000 check this week. That hurt, but it’ll end up helping in the end. You see, the $4,000 was bound for my Roth IRA–my 2007 contribution. [...]
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