Roth IRA Explained

In my article “Investing in the IRA Alphabet Soup” I fangirled about the Roth IRA and hinted I may do a dedicated post at some point.  WELL HERE IT IS!  An in-depth look at the Roth IRA and why, if you’re eligible to have one, you should totally have one.  It’s probably one of my favorite retirement vehicles because it offers the Average Joe a better chance at a worry-free retirement.

Using the Roth IRA to Find the Way Out of the Retirement Maze

Can the Roth IRA Help in Your Retirement Race?

If you’re like me, your college education was a fantastic experience, but you didn’t get a six figure job handed to you right off the stage.  Instead, you’re working in the $30-45,000 a year and clawing and grinding towards the top.  What this means, in the scope of the Roth IRA, is you have more income tax brackets above you rather than below you and for once that’s a good thing due to how the Roth treats contributions compared to a Traditional IRA.

Tax Advantages of a Roth IRA

There are some blogs out there that assert that the Roth IRA is silly because they know better than the government on what to do with those taxed earnings in the meantime.  That’s a fair point; however, generally the people making this point are the ones either ineligible to contribute due to income requirements, or don’t benefit from the Roth as much because they’re making $100,000 or more.  The reason the Roth has income requirements is because the wealthy disproportionately benefit from growth in stocks.  By acting as a vacuum for all of the monthly leftovers between expenses and income, the Roth IRA is able to give the average American extra exposure to the tremendous wealth builder that equities can be.

The beauty of the Roth is that you contribute with net income rather than gross income; that means when you start taking money at some point after 59.5, it’s tax free!  Why is that an advantage?  Well, like I mentioned above, you have more tax brackets above rather than below.  I’m hoping and praying that when I retire in 40 years I will be living on more money rather than less; I already feel like I couldn’t take a pay cut.  Compared to a Traditional IRA, if I’m living on more money than I am right now, my distributions would be taxed at my higher income level, not my current – that could be the difference of a few thousand dollars a year.

Another neat advantage of the Roth IRA are the early withdrawal benefits.  If you get in a bind you can freely take any of the contributions you’ve made.  Just be sure not to use your Roth IRA like an extra savings account, it is for retirement.  I want to be very clear on this though – before 59.5, you can only take direct contributions that you put in.  Any earnings your IRA has made are still untouchable until 59.5.

Some Things to Consider About a Roth IRA

The Roth does have an income and contribution mandate attached.  For 2016 the maximum contribution you can make a year is $5,500 if you’re under the age of 50.  After 50 you can contribute an additional $1,000 making your total $6,500.  For income requirements, a person filing as single can earn up to $117,000.  After that you phase Roth IRA phase-outs (meaning the amount you can contribute goes down) up to $133,000.  For a married couple, they can make up to $184,000 with phase-outs up to $194,000.  In the grand scheme, if you’re making over $65,000 right now you should probably be using your company’s 401(k) (or SEP IRA if self-employed) or a Traditional IRA.  With the median income at around $50,000 it’s foreseeable that your income will go down in retirement, so take advantage of the tax benefits that fit your situation.

Another nifty feature of the Roth IRA, for those that cannot contribute is a Traditional IRA to Roth conversion.  This is exactly what it sounds like.  Someone contributes money into a Traditional IRA and then converts it to a Roth by paying the taxes on the contributions – there is a little more to it than that so be sure to talk with a financial professional if you choose to go this route.  Why would someone do this?  Well, if they want to accrue earnings tax-free of course!  Let me give you an example.  Say we have a fella who makes $145,000 a year and contributes the full $18,000 to his 401(k).  He’s single and without a family so his monthly expenditures are much lower.  He knows, based on his 401(k) he’ll likely be okay for retirement so he does an IRA conversion and invests solely in stocks that he thinks will skyrocket over the years – maybe something like Netflix before their 7:1 split.  Essentially using the Roth as an educated gambling fund.  That way, if he hits it big and jumps to the next tax bracket, it won’t matter for those capital gains.  That’s just one scenario, there are multiple reasons why someone would want to convert their IRA.

The Takeaway

The Roth IRA can be a powerful tool in a retirement portfolio for those making less than $65,000 a year.  For those who believe they will live on more money in retirement than they do now, looking at it from a probability standpoint, the Roth is probably the way to go.  The Roth also provides early withdrawal benefits that the Traditional IRA simply doesn’t.  Just make sure you’re eligible to even open a Roth.  While it shares the $5,500 contribution limit a year, the Roth also imposes an income limit – $133,000 for a single filer and $194,000 for a married couple.


Readers, how do you contribute and plan for retirement?  Let me readers know why you chose your specific plan in the comments below.  For a look into why I think I’ll make more in retirement than I do now, check out this article.  Be sure to ‘like’ Cash Flow Celt on Facebook to get all of the newest updates and be sure to share if you enjoyed the article – let your friends you’re out there conquering your financial empire!


Cash Flow Celt

I'm just a local business and finance nerd looking to help people get educated about small business, marketing, and personal finance! I write about anything and everything that I can tie into those themes. I'm also Central Florida's only Kilted Realtor, so I write about Real Estate too! Check out my About Me page to see the origins of Cash Flow Celt.

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2 Responses

  1. Great post. I think the Roth IRA is the single best investment the U.S. government allows us to use. Thanks to Backdoor conversions, I’m able to participate.

    • Cash Flow Celt says:

      Thanks for stopping by! For it’s overall use and applicability, the Roth is my favorite; however, I actually prefer the SEP-IRA the most, even though it’s a Traditional IRA. It’s higher contribution limits and overall flexibility make it a great tool. Plus, you can then still contribute to a Roth on the side to try and diversify your tax advantages.

      The backdoor conversion is incredibly useful. If you don’t mind me asking, what sort of assets are you trying to grow tax-free?

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