In the world of retirement investing, there is one term you should get extremely familiar with: Roth. This is especially important if you are a young person. Right now, we will focus on Roth IRAs and the less common Roth .
Essentially, Roth accounts are funded by after-tax money rather than pre-tax, but we will go into specifics shortly. We won’t get too technical in the write up! It’s hard enough to know how long to keep your taxes, let alone all of the rules and regulations that made Roth accounts possible!
If you’re one of our Canadian friends to the north then be sure to check out an excellent article on TFSAs (Tax Free Savings Accounts) at Invest It Wisely!
If you are a young person, then we’re sure that you’re planning on making more money in the future. Generally, it’s a great thing!
There is one caveat: taxes. If you make more money, then you’re probably going to end up in a higher tax bracket and paying out more in taxes.
This is where Roth accounts come into play. After you pay your taxes on your income you put the money into your Roth account, and wait until retirement.
After a certain age, currently 59 1/2, you can withdraw the money tax-free without penalty.
A Roth IRA (Individual Retirement Account) can be housed at any financial institution such as a brokerage firm or a bank. Basically, it allows you to invest in various securities like common stock & mutual funds with after-tax dollars.
So the only tax liability that your investments have are paid up-front. This is great because generally people plan on making a lot more money than they do when they are younger. There are certain requirements such as income caps, contribution limits, etc. As stands, a single person can invest up to $5,000 each year if they are younger than 50, and $6,000 if you are 50 or older.
Some drawbacks to investing in a Roth account is that the contributions are not tax-deductible. Additionally, if you are in one of the higher tax brackets it may not be advantageous to invest in this kind of account. For more information on the rules and to see if you should use this account check these resources:
A Roth 401K is very similar to the IRA. It is a relatively new investment option being offered by a couple of employers. It essentially works the same as a traditional 401K but it is instead funded with after-tax dollars rather than the before-tax dollars that you might be use to. Again, this type of investment is generally going to be far more advantageous to someone in a lower tax bracket right now. For more information about Roth 401K, use these resources:
- IRS.gov – Roth 401K Resource Site
- Roth 401K vs Traditional 401K Comparison Calculator