Dear Liz: Everyone talks about Roth IRAs and how beneficial they are. But I am self-employed, my husband contributes 16% toward his 401(k), our house is paid off, and we no longer have dependents to deduct on our 1040 tax return. My contribution to my traditional IRA is the only tax deduction we have left. Should I consider a Roth anyway? If so, why?
Answer: A Roth would give you a tax-free bucket of money to spend in retirement. That would give you more flexibility to manage your tax bill than if all your money were in 401(k)s and traditional IRAs, where your withdrawals typically are taxable. Also, there are no minimum distribution requirements for a Roth. If you don’t need the money, you can pass it on to your heirs. Other retirement funds require you to start taking money out after you turn 701/2. If you need to crack into your nest egg early, on the other hand, you’ll face no penalties or taxes when you withdraw amounts equal to your original contributions.
So is it worth giving up your IRA tax deduction now to get those benefits? If you have a ton of money saved, you want to leave a legacy for your kids and you’re likely to be in the same or a higher tax bracket in retirement, the answer may be yes. If you’re like most people, though, your tax bracket will drop once you retire. That means you’d be giving up a valuable tax break now for a tax benefit that may be worth less in the future.
You may not have to make a choice, however, between tax breaks now and tax breaks later if you have more than $5,500 (the current annual IRA limit) to contribute. Since you’re self-employed, you may be able to put up to $51,000 in a tax-deductible Simplified Employee Pension or SEP-IRA. At the same time, you could contribute up to $5,500 to a Roth (assuming your income as a married couple is within or below the phase-out range for 2013 of $178,000 to $188,000).
This would be a great issue to discuss with a tax pro.