Roth IRA pays off in the long run

Although Roth IRA’s have been around since 1997, they often don’t receive enough attention and consideration by those saving for retirement. Many savers default to the current tax-deduction benefit of traditional retirement accounts — (401(k) and traditional IRAs — and leave contributing to a Roth IRA only “when they have some extra money.” In traditional retirement income planning, Roth IRA accounts often are left as the last resource for income because of the tax-free benefit of withdrawals, which is good for heirs as well if the Roth IRA is left in an estate.
As a financial planner, I’ve strongly encouraged clients to not only contribute to their tax-deductible retirement accounts, but a Roth IRA as well. My reasoning is not as much for an effective estate-planning tool, but one of retirement income planning. While many advisers may recommend leaving the Roth assets until the latter end of life for income, for many years I’ve advocated using the Roth IRA and its tax-free withdrawal benefit in tandem with other accounts to minimize the taxable amount of income in retirement.
Because of our nation’s fiscal and deficit/debt problems, this strategy may become more important than ever for today’s and tomorrow’s retirees for minimizing taxable retirement income.
The recent Affordable Care Act of 2010 (aka “Obamacare”) provides an important example of these implications. Beginning this tax year, those with higher taxable income will have a new Medicare surtax on their income of 0.9 percent. In addition, those in higher tax brackets also will have to pay a new Medicare tax of 3.8 percent on investment income and further legislation raised the capital gains and dividend tax rate to 20 percent for high-income taxpayers.
Most of you may not feel all that concerned about these new taxes, since your income may not be close to the legislated definition of “high-income”: Modified Adjusted Gross Income of $200,000 for single taxpayers or $250,000 for married couples filing jointly. What many don’t realize is that there is no inflation adjustment on these income thresholds. In other words, unless adjusted by Congress, these levels apply now and in the future. Consequently, as incomes rise over time with inflation, more taxpayers may be subject to these new Medicare taxes, just as more are subject to the Alternative Minimum Tax today than several years ago.
A Roth IRA could help with these and other potentially higher taxes on income as governments try and find more ways to subtly extract taxes from citizens to help close the gaps between spending and tax revenue. By having a sizeable Roth IRA, a retiree might withdraw income from both traditional accounts and their Roth IRA to potentially keep their effective taxable income in lower brackets. This may help in avoiding some present and future income or supplemental taxes intended for those “higher-income” citizens.
As governments become more creative with how they tax us, we have to be more creative with how we manage our tax liabilities. If you have questions on how a Roth IRA may benefit your retirement planning and tax situation, be sure to consult with experienced tax and financial professionals.
Kevin Worthley is an investment adviser representative of Wealth Management Resources Inc., a registered investment adviser. The opinions expressed above are his only and sources used for this article may be deemed reliable, but cannot be guaranteed. He can be contacted with questions or comments at 356-1400.
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