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Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Friday, October 16, 2009

Why You Should Consider a Roth IRA

Back in July we wrote about changes in the tax law that will make converting regular IRAs to Roth IRAs much easier (“Roth IRA Conversions Will Be Easier in 2010”, July 14th, 2009). After attending the Financial Planning Association of Michigan’s annual fall symposium and listening to a presentation by IRA expert James Lange, we thought it would be worthwhile to re-emphasize the benefits of Roth IRA accounts.

If you have earned income you may contribute $5,000 annually to a Roth IRA and $5,000 for your spouse, if you are married. If you are over age 50 you can contribute $6,000, annually. As you probably know, contributions to Roth IRA accounts are not deductible but grow tax free until withdrawn if certain conditions are met. For 2009, to make the maximum contribution, you must have Adjusted Gross Income less than $166,000 if you are married and less than $105,000 if single. Earned income must be at least as much as the amount you contribute to the Roth IRAs.

Generally speaking, withdrawals made after age 59 and ½ and held in the Roth account for at least five years are tax free. Contributions to Roth accounts can be made at any time, tax free. The rules regarding distributions can be a bit complex and warrant a separate article dedicated to that subject.

Another benefit to Roth IRAs is the fact that distributions do not have to be made at age 70 and ½, as is the case with regular IRA accounts. This makes it possible for Roth IRAs to grow tax free much longer than regular IRAs.

In Mr. Lange’s presentation, he gave examples of the benefits of Roth IRAs. One example showed the benefit of converting your $100,000 IRA to a Roth IRA. Mr. Lange projected that you would be $51,227 ahead after a 20-year period (reasonable assumptions were made).

Mr. Lange then went on to consider the scenario where you die 20 years later but leave the Roth IRA to your 55-year-old child. The benefits to your child would be $1,537,493 in future dollars or $260,963 in today’s dollars adjusted for 3% inflation! The benefits for a grandchild would be even greater.

The bottom line is that if you haven’t considered contributing to a Roth account, you should give it serious consideration. And with the new rules in affect starting in 2010, it will be even more cost effective to convert regular IRAs to Roth IRAs. With the income cap eliminated in 2010, anyone will be able to convert their regular IRAs. Just make sure you have enough money outside of the regular IRA to pay the taxes due.


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