oth Individual Retirement Arrangements (IRA)s. In accordance with 105th Congress Public Law 34, the Taxpayer Relief Act of 1997, gave birth to the Roth Individual Retirement Arrangements (IRA).
Per Section 302, it established the Nondeductible Tax-Free Individual Retirement Accounts which means "No deduction shall be allowed under section 219 for a contribution to a Roth IRA."1
This form of retirement contribution account allows the same amount as the traditional IRAs. The maximum contributions allowed are 100% of earned income up to an indexed maximum. These figures are enforced by the Internal Revenue Service and from 2015-2018, the annual total contribution cannot be more than $5,500 ($6,500 if one is age 50 or older) or taxable compensation for the year is/was than the dollar amounts.2 For the latest year of 2018, contributions may be affected by the amount of one's Modified AGI. See below.
1 105th Congress Public Law 34. U.S. Government Printing Office. Taxpayer Relief Act of 1997. Retrieved from
2 Retirement Topics-IRA Contribution Limits. IRS.gov
Unlike its counterpart, Traditional IRA, the Roth version of an account allows one to make after-tax contributions. This means if Susan, 34, is working full-time earning less than $189,000 in modified AGI, so we will say $45,000 annually, then she may contribute up to $5,500 a year. Breaking this down into monthly payments total $458.33.
Another benefit to the Roth IRA is the ability to make contributions past 70 1/2 years of age, meaning one is not bound to immediately start the withdrawal process at age 70 1/2. However, should Susan get a promotion that cause her earn more than the modified AGI listed by the IRS, then she may risk the inability to invest in a Roth IRA.
Best Way to Supplement Your Retirement Savings
When it comes to retirement, no one investor should rely on one source. A future retiree should build a triad of savings. This triad should closely resemble a stool with each stool leg representing each account. Since most corporations have done away with pensions, they have replaced it with 401(k)s. The first leg of your retirement should be the maximum amount possible.
The second leg is Social Security. Social Security is a significant source of income for many households. According to the Social Security Administration, "48% of married couples and about 69% of unmarried persons receive 50% or more of their income from Social Security".
The third leg is an IRA. According a survey by TIAA-CREF, 80% of U.S. workers weren't contributing to an IRA. This type of investment is very attractive because of its tax treatment. Unlike a traditional IRA where taxes are paid later when making withdrawals upon a qualified retirement age, a Roth is taxed initially withdrawals are generally tax-free.
Even if one participates in a qualified plan at work, he or she can still contribute to an IRA. In 2019, if one is under the age of 50, the annual contribution is $6,000 which equates to $500 per month. If you are not budgeting to make this regular contribution, starting funding your IRA after you've become debt-free and have established an emergency fund.
In the related articles link, "Traditional IRA vs. Roth IRA", I outline a case where both types earn the same Net Value, based on the same tax rates, all things considered. The real question when it comes to investing in which IRA type is where will future taxes be compared to today's rates. Since nobody has a crystal ball, take a look at your finances and discuss with a financial planner which type may be best or ideal for your financial situation.
Establishing a Systematic Withdrawal
When it comes time for you to retire, there are several options you need to consider when making withdrawals from your Roth IRA. The first option is to pull random amounts out of the account when you need it. The second option is to live on the interest and dividends earned to include any price appreciation the account may have generated. The third option is to establish a systematic withdrawal plan. Below we will explore the impacts of each strategy.
The first option is just not ideal. By pulling out random amounts based on your desired cash flow needs, it creates an unstable principal account for your money to continue growing plus it is more likely that you will outlive your money.
When a retiree pulls out the interest and dividends earned from one's retirement account, it presents a few issues. Interest and dividend income is not always consistent. The interest from bonds may pay out on a semi-annual basis while dividends may pay every quarter. For retirees, this may not be ideal if one is looking for regular, consistent income.
Making a plan to not withdrawal the dividends and interest will allow the account to continue earning money on money. Instead, seek to withdrawal a consistent amount each month that will continue to enable your investment to grow.
A diversified portfolio keeping pace or exceeding annual inflation allows your retirement account to grow while allowing regular withdrawals.
The next time you speak with your financial advisor, ask what plan he or she can assist you with that will ensure you can take a Systematic Withdrawal.