And is it possible to contribute if you don’t earn income that year? Thanks.
Roth IRAs are better because you don’t have to pay taxes on the money when you withdraw it since you already have paid them.
This is an advantage because you will presumably be in a higher tax bracket when you’re young than when you retire, so you essentially pay less tax.
I would assume that you can make a Roth IRA contribution since you don’t deduct that from your taxes, so it wouldn’t impact your IRS bill in any way. But I am no expert on taxes or investing, so wait for the experts.
I believe that a Roth IRA is better than a traditional IRA because with the Roth, it goes in after taxes and is therfore not taxed when you withdraw the funds. As opposed to pre-tax funds (comes out of your paycheck pre-tax and goes into an IRA) which are taxed upon withdrawal from the IRA.
I dont see why you would not be allowed contribute even if you did not have any income. If you have questions, contact your/a investment business such as Fidelity.
hope that helps 
Yeah, but what if the federal income tax is abolished before you retire, huh? What then, smart guy?
Or what if we’re conquered by France and American dollars are declared valueless? Um, never mind-I should stick to more realistic possibilities.
When I was looking into IRAs there was a maximum amount you could earn before you were not allowed to put money into an IRA but no minimum.
Or what if when you retire the government is so broke they decide to start instituting some sort of means testing when deciding how much social security to pay out
effectively taxing the ROTH IRA. This seems much more reasonable than taxes being abolished.
Here’s a concrete example I used recently to explain to someone:
Remember, you don’t have to take out the money on retirement, it’s just if you start taking money out before you’re 59.5, you pay a penalty (and on a traditional, you also pay taxes as if it were income).
With a traditional IRA, you must start making withdrawls when you get to 65 (I think) so the gov’t. can get their cash back. With a Roth, you’ve already paid and can even roll the IRA over to your heirs and they can use it as their IRA. I think you can also roll it over into colelge funds, etc., but I’m not sure.
For both the Roth and the Traditional the limits for this year are $3,000 (unless you’re within 5 (?)years of retirement), but they’re increasing the amount you can put in, within 10 years, IIRC, it will be $6,000 in both types of IRA.
The Roth is clearly the way to go, the tax savings now are not adequate to make the traditional worthwhile.
Chairman Pow.
I don’t see why you say that the Roth is clearly the way to go. Just adding up the money saved in taxes is not a good way of telling if Roth is better than traditional. Presumable you don’t just stuff this money under a mattress you use it. You save $810 in taxes every year. You invest this at a 12% return and pay the same 27% taxes each year for 43 years (from your example) on your income you will have about $250,000 beyond the Roth IRA. Not $34,830.
If you already have a 401K or equivalent plan at work you should use a Roth IRA instead of a traditional IRA, sayeth our accountant.
And gazpacho, please let me in on where you are finding a 12% return these days.
As others have stated, the distinction between a Roth and a Keogh plan is that money is put into a Roth post tax (or, alternatively, you don’t get a tax break the year you put it in).
I’ve been rolling my old investments that had been given to me as a child into my Roth for years now, including in years when I had no income to speak of. There is a cap of $3000 (IIRC) that may be put in each year, and frankly I think that it’s the best thing you can spend $3000 a year on if you can afford it.
A Keogh plan is taxed when you withdraw the funds. You will pay taxes one way or the other, but you get to choose when you’ll pay them. I (as an example) am currently making little enough at 25 that my tax bracket is almost at the bottom. By the time I get promoted to emeritus, I’ll be in a significantly higher bracket and if I paid the taxes then, a larger fraction would get sucked away, not to mention all the interest that would be taxed as I drew it out. Even without numbers, the Keogh seems to me (a mathematician, not an accountant) to be a sucker’s deal.
Money placed into a Roth IRA has to be “earned income” according to IRS rules.
So, suppose you want your newborn to start things right, and open a Roth for them?
Easy, You find a friend of the same income level, and the same sort of long term planning. You hire their kid to model for some baby pictures. They hire yours to do the same. You pay each kid the limit that you want to invest. Then the kids put the earned money into their Roth. Every year you take more pictures, and you pay the kids their modeling fees. You offer the prints to baby magazines, and maybe get your money back, maybe not. The money is yours, though. Unless you write them a contract for residuals.
I recommend that you follow Warren Buffet’s advice on buying stocks for the kids. Buy low, don’t sell.
My Roth is currently at 155 percent of my total investment, after only a year and a half. I started late, though.
Tris
I don’t think the rules say that the income must be earned in the same year that it is invested. So, if you earned a bit extra last year, and still have it, you can invest it this year. (and this year lasts until April 15th of next year, by the way.)
I am not a lawyer.
Tris
I’m not sure about this. The money I’ve been rolling over into my Roth (or, technically, having the guy at AmEx roll in) is from various mutual fund accounts that were held in my mother’s name for me under the Uniform Gifts to Minors Act until I turned 18. Now, when she signed those accounts over to me, did that count as me “earning” it? Is there a special clause in UGMA that makes such gifts count as earned income for such purposes?
IMHO, the case where a Roth makes most sense is if you have some extra money on hand that you’d like to put into savings for retirement. Since you’ve already been taxed on that money, a Roth is great for letting it grow tax-free, and then letting you withdraw it tax-free.
It’s a little more murky if you already have pre-tax savings in something like a 401(k). Then it starts to get a little speculative about whether it’s better to take a tax hit now and roll it into a Roth, or to keep it tax-free until you want to do withdrawls.
Sorry, this is basic stock market mistake #1. Previous returns are no guarantee - or even indicator - of future returns.
Official site for what you can contribute to a Roth IRA. There is a requirement for earned income. If you don’t have earned income but your spouse does, your spouse can contribute for you.
http://www.irs.gov/newsroom/article/0,,id=106947,00.html
I have a Roth IRA and have used it as an alternate investment when circumstances have limited my ability to contribute to my usual investments. For example, a waiting period for a new employer’s 401k and the temporary suspension of a stock purchase plan. This way I kept in the habit of saving. It was easy to just plop the money in there and know I wasn’t falling behind. I can’t say I see it making me rich, though.
I think the Roth makes more sense the younger you are. You are likely to be in a low tax bracket and when you eventually take the money out in retirement a higher proportion will be interest, as compared to an older investor.
Reread the example: assuming my 12%/yr (Exapno, he got it from my example, which I got arbitrarily), I will have approximately $3.2 million/year, and have paid approx. $127,000 over that period in taxes. When I take the Traditional out (assuming that same tax level), I will pay $864,000 in taxes.
I don’t know what math you’re using to get your $250,000: at 12%/yr for 43 years, an initial investment of $810 will net me ~$94,545.74 assuming my first year is just a contribution, $105,891, assuming I make 12% the first year as well, and that’s not paying any taxes on any of it. Assuming that we pay 27% taxes (unrealistic as we’d be paying capital gain taxes, etc.) we’re paying $25527.35 in taxes, leaving us with $69018.39. In the second example (the first year also earns 12% interest), we’re paying $28590.63 in taxes, leaving us with $77300.60. And we’ve still got the ~800,000 in taxes from the Traditional IRA! As I figure it, we're coming out ~700,000 ahead with the Roth.
Please explain your math to me.
Remember the other benefits metioned for the Roth. I maintain that this is a better investment. Of course, an individual’s personal situation may not allow them to invest the full amount; they might be too close to retirement, they may need that $810 to make some bill payments, etc., but all things being equal, the Roth seems best.
I’m not going to do the math here but the way I look at it is this:
With a traditional IRA there is a clear immediate benifit (tax write off) each year (if you don’t have access to a 401K).
With a Roth there is not.
With a traditional IRA the taxes that you would’ve paid up front also get to grow along with your investment. So the bet is that you’ll be in a higher tax bracket then, but who really knows? When I retire (and don’t have an income) won’t I potentially be in a lower tax bracket?
What if they abolish the income tax by then. What if they’re lower? There are too many unknowns and you’re giving up a tangible benifit (write off) up front.
Is this flawed thinking?
You could potentially be in a lower tax bracket, but I’m pretty sure that’s not usually the way it works. Of course YMMV, but I think most people’s earnings are increasing up until they hit 65. In fact, many people keep working past 65. Tax brackets, thus, generally go up. Also, the percentage the gummint wants tends to go nowhere but up. Also, remember that when you pay the tax on something like a 401(k), you also pay tax on the interest that’s been compounding. With a Roth, you get all that interest (which can be very sizeable if you’ve been saving it since 18) for free.
As for abolishing the income tax, very unlikely. Yes, it’s an unknown, but one whose effect is so minimal when amortized against its possibility of actually happening. I’d put taxes going down enough to offset your increased income in a similar basket.
And if there’s a large enough event to destabilize the country as a whole, neither plan will be worth a damn.