NEWS AND RESOURCES

Financial Planning for January 2014

8 Reasons to Manage Your Investment Portfolio in a Roth IRA

You may wonder why you should place investments in a Roth when you would lose the current tax deduction on contributions to a tax-deferred account. The following are eight good reasons why.

  1. Tax-Free Withdrawals
    With a Roth IRA, contributions are not tax deductible. They are subject to your annual income taxes, but withdrawals are tax free and penalty free once you reach age 59½ (as long you’ve held the account for at least five years). Since your Roth can grow tax-free, consider using this account for your stock portfolio to avoid taxes on gains.
  2. Investment Options
    Many IRAs offer a wider array of investment options than a 401(k) plan. You may build a portfolio comprised of individual stocks and bonds, certificates of deposit (CDs), mutual funds or exchange-traded funds (ETFs). You also have the option to select a single fund allocated to suit the target date you wish to begin drawing funds.
  3. Liquidity
    If the assets in your Roth have been held for fewer than five years, any interest or dividends you withdraw will be subject to taxes. If you withdraw those gains before you are 59½, the money distributed will be subject to a 10 percent tax penalty. However, unlike a traditional IRA (or other tax-deferred accounts), with a Roth you have the ability to withdraw your contributions at any time without penalty.
  4. Invest more than the annual limit
    All IRA contributions are capped at $5,500 per year; $6,500 for age 50+ (2014). However, if you invest in dividend stocks, you can instruct your asset manager to reinvest your dividends to purchase additional shares – essentially allowing you to make a higher contribution to your account than restricted by the annual limit. As those shares generate more dividends, you can continue the cycle of buying more shares in addition to the shares purchased with new annual contributions.
  5. First Home Down Payment
    If you start contributing early in life to a Roth, once you’ve held the account for at least five years, you can withdraw all of your contributions and up to $10,000 of earnings to buy your first house – both tax- and penalty-free.
  6. Assets not considered for financial aid
    Assets in a Roth IRA are not counted when in determining the expected family contribution (EFC) for purposes of federal financial aid to college students. This is true for a Roth account owned by parent or student.
  7. No Required Minimum Distributions (RMD)
    You are not required to withdraw any money from a Roth during your lifetime. If you don’t need the money in retirement, you can leave it to grow tax-free for your heirs.
  8. Tax-Free Inheritance
    When you pass away, your heir may receive the account proceeds via annual distributions or a lump-sum payout free of capital gains or income taxes. Note that Roth IRA assets are subject to estate taxes, but today’s generous estate tax exemption ($5,340,000 in 2014) will allow these assets to pass altogether tax free for many Roth owners.

Furthermore, while a traditional IRA makes annual payouts to your heirs based on your life expectancy, the Roth schedules payouts based on the heir’s life expectancy. This means the money can stay in the account – and continue growing tax-free – for a much longer time. To take advantage of this benefit, the heir must make his first withdrawal by Dec. 31 of the year after the IRA owner’s death. Otherwise, he’s required to deplete the account by the end of the fifth year following the year of death.

Anyone can who has earned income can open a Roth account, regardless of age. Note, too, that participation in an employer-sponsored retirement plan does not impact your ability to contribute to a Roth IRA. You may make a full contribution to a Roth IRA if your adjusted growth income (AGI) is less than $114, 000 (single filer) or $181,000 (joint filer). Contributions are subject to phase-outs for singles earning more than $114,000 and couples earning more than $181,000.

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