Delaware’s greatest Senator of the modern era isn’t the one that became Vice President and believes that unemployment welfare checks help grow the economy. Rather, it was the late Senator William Roth of Delaware who devised the means by which you can create for yourself, your children, and even your grandchildren the ability receive a lot of money and never pay a dime of taxes on that money.
That wonderful means of creating wealth is called the Roth IRA.
The Roth IRA allows anyone at a modest income level can live tax free from the millions (yes millions) of dollars they have saved.
Let us start with someone in their thirties with nothing saved for retirement. Their income or financial situation may not allow for them to put away the maximum amount for a 401K (currently $17,000 with an additional $5,500 in the year they turn 50). So perhaps putting away the maximum for a Roth IRA is more accomplishable.
If this 30 year old contributes $5000 a year to a Roth IRA (this is an after-tax contribution meaning that Uncle Sam gets his money now, and not later on the earnings), and will also contribute an additional $1000 when turning 50, an average rate of return of 6% will net them $615,227 in savings. This person who started with nothing and saved for 35 years can now receive an income of about $48,000 per year and pay no taxes on that money. Compare that to the failing Social Security where putting away that much money every tear gets you a paltry $28K a year which, in some circumstances, is taxable. Perhaps Social Security would be better off using the Roth IRA model where the Government gets its money up front to waste, and you reap the benefits of tax free income when you need it the most! By the way, this calculation uses the current 2012 planned maximums. They could go up in future years.
If someone started this when they were 22 instead of 30, the savings are $1,018,463, with an annual tax free income at age 65 of about $70K.
Your Roth IRA contribution is limited or reduced depending on your income level. You can get the details from the IRS at http://www.irs.gov/publications/p590/ch02.html. Many people lower their adjusted gross income (AGI) by also contributing to tax-deferred plans like traditional IRAs or 401k plans. If you are at a higher income level, and decide to contribute to a tax-deferred plan like a 401K, you can contribute any amount to this and still pay lower taxes during the years you contribute. If our 30 year old also contributes the maximum amounts with an average 6% rate of return can retire with over $3 Million in savings, but it will be taxed upon withdrawal. If that is what you want, consider letting the Roth IRA grow for the rest of your life to provide a tax-free gift to your children or grandchildren after you pass on. Our 30 year old, can pass on well over $2.6 Million of Roth IRA to their heirs (if they live to be about 90), and our 22 year old can pass on their Roth IRA savings of over $3.5 Million tax free.
More Benefits of the Roth IRA
- There is no mandatory withdrawal date. Most retirement investment programs require you to begin making withdrawals on your investment when you reach 70 ½ years of age. The Roth IRA does not impose this same requirement.
- You can contribute to your Roth IRA with no intention of ever making withdrawals, and your beneficiaries can inherit the account with no penalties or payment of taxes. Fool.com clarifies this even further by stating, “a Roth IRA will allow you to continue to build up the value of the IRA free from all income taxes for the benefit of your heirs. While estate taxes may have to be paid on the value of the Roth IRA upon your death, no part of the Roth IRA will be subject to income tax to your beneficiaries. This is completely different from a traditional IRA. The value of a traditional IRA will be included in your estate. But the traditional IRA earnings will also be taxed as income to your beneficiaries.” For non-spouse beneficiaries, they will have to wait five years after the account-holder’s passing before receiving distributions tax-free.
- You are free to invest the money in your IRA however you chose such as in common stocks, index funds, bonds, REITs (real estate investment trusts) and certificates of deposit (CDs).
The only real danger is if in the future, politicians decide that you are no longer paying your “fair share” and decide to change the laws to eliminate increased generational wealth.
Wealth Virtues by James Ward provides tools and guidance on how to learn to invest wisely. It also delves a bit more deeply into the advantages of contributing to 401Ks as well as both the Roth and Traditional IRAs, allowing anyone, at any income level, define and achieve their own wealth.