For those focused on saving for retirement, much of the focus during tax season is the potential tax deductions received by contributing to a Traditional IRA or other tax-deferred account(ie 401k, 457b, or 403b).
While a common starting point, tax deductions are great, and your tax preparer might even recommend it. But is taking that deduction now and your tax preparers advice shortsighted???
This begs the question. Should you consider a Roth IRA?
There are several reasons why it may be a good time to consider opening and funding a Roth IRA with an after-tax contribution before the April 15th tax deadline, assuming you qualify.
Why April 15? Because, if you haven’t reached the annual contribution limit for the current tax filing year, you may still contribute to a new or existing IRA. Just make sure to ask your custodian what their process is.
Unlike Traditional IRA’s, contributions to a Roth IRA are made after tax and do not provide a tax deduction. Investments in a Roth IRA grow tax-free. All you need to do is ensure the account is established for at least 5 years or distribute the funds after age 59.5 and IRS rules are followed.
A Roth IRA can give you the opportunity to invest in:
- Stocks
- Bonds
- Real estate
- Mortgages
- Private Debt
- Private Equity
- Digital Currency(Crypto)
- and More…
Here are three reasons to consider opening a Roth IRA right now:
1) Boost your Tax-Free retirement savings.
If you ever thought about opening a Roth IRA but didn’t last year, now is the last opportunity before the April 15 deadline.
Making contributions before filing to your Roth IRA provides an opportunity to make up for lost time without reducing the amount you can contribute in the current tax year. Remember, once each filing season is over you have forever lost your opportunity to make a tax-free Roth IRA contribution.
Example
Let’s assume a Person A diligently maxes their Roth IRA contribution over 8 years. Person B is busy with other tasks and misses every other year. They each decide on the same investment in year 9 and double their money.
Person A ends up with substantially more tax free assets.
2. You no longer qualify for a tax deduction on your Traditional IRA. Then consider a Roth.
You might not be aware, but the IRS limits who can receive a tax deduction from the Traditional IRA contributions if you are covered by a retirement plan at work.
Retirement savers who exceed Modified Adjusted Gross Income(MAGI) limits may only qualify for a partial or no additional deduction at all.
For employees covered by a workplace retirement plan, such as a 401k or 457b, the MAGI limits for Roth IRA eligibility are significantly higher than the MAGI limits that phase out the ability to deduct Traditional IRA contributions. In other words, it makes more sense to contribute to the Roth anyway.
3. Save a full year and start your Roth IRA “five-year seasoning” now!
When you establish a Roth IRA and make contributions before the April 15 deadline this retroactively sets the start date for the five year seasoning period to January 1st of that tax year. If you wait until after April 15th to open and fund your account the five-year seasoning period starts on January 1st of that year instead.
You may be wondering what’s the big deal. The 5-year seasoning period for Roth IRAs is important for two reasons:
- Distributions from your Roth IRA are not fully tax or penalty-free until after the account has been established, or seasoned, for 5 years. This applies even if distributions are made after age 59.5.
- Roth IRAs allow you to withdraw the money contributed out of pocket into the account(not earnings) tax and penalty-free. But this is true only after the account has been established for 5 years.
Bonus Reason #4
Your tax preparer or CPA might say contributing to a Traditional IRA will save a couple of hundred dollars on taxes now. Sure, it’s great to save a little extra money each year. But let’s say your Roth IRA grows to $1 million dollars by the time you retire. You then decide to take all the money out in one lump sum. Let’s take a look assuming only 2020 Federal tax rates apply. Here is the difference between a Traditional IRA & Roth IRA.
Is saving a couple hundred dollars each year worth paying $329, 839 in Federal taxes later???
