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Roth IRA

Using a Roth for college: hazards and benefits

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Dear Liz: My husband and I have been putting 5% and 6%, respectively, into our 401(k) accounts to get our full company matches. We’re also maxing out our Roth IRAs.

The CPA who does our taxes recommended that we put more money into our 401(k)s even if that would mean putting less into our Roth IRAs. We’re also expecting our first child, and our CPA said he doesn’t like 529 plans.

What’s your opinion on us increasing our 401(k)s by the amount we’d intended to put into a 529, while still maxing out our Roths, and then using our Roth contributions (not earnings) to pay for our child’s college (assuming he goes on to higher education)?

Our CPA liked that idea, but I can’t find anything online that says anyone else is doing things this way. I can’t help but wonder if there’s a catch.

Answer: Other people are indeed doing this, and there’s a big catch: You’d be using money for college that may do you a lot more good in retirement.

Contributions to Roth IRAs are, as you know, not tax deductible, but you can withdraw your contributions at any time without paying taxes or penalties. In retirement, your gains can be withdrawn tax free. Having money in tax-free as well as taxable and tax-deferred accounts gives you greater ability to control your tax bill in retirement.

Also, unlike other retirement accounts, you’re not required to start distributions after age 70 1/2. If you don’t need the money, you can continue to let it grow tax free and leave the whole thing to your heirs, if you want.

That’s a lot of flexibility to give up, and sucking out your contributions early will stunt how much more the accounts can grow.

You’d also miss out on the chance to let future returns help increase your college fund.

Let’s say you contribute $11,000 a year to your Roths ($5,500 each, the current limit). If you withdraw all your contributions after 18 years, you’d have $198,000 (any investment gains would stay in the account to avoid early-withdrawal fees).

Impressive, yes, but if you’d invested that money instead in a 529 and got 6% average annual returns, you could have $339,000. At 8%, the total is $411,000. That may be far more than you need — or it may not be, if you have more than one child or want to help with graduate school. With elite colleges costing $60,000 a year now and likely much more in the future, you may want all the growth you can get.

You didn’t say why your CPA doesn’t like 529s, but they’re a pretty good way for most families to save for college. Withdrawals are tax free when used for higher education and there is a huge array of plans to choose from, since every state except Wyoming offers at least one of these programs and most have multiple investment options.

Clearly, this is complicated, and you probably should run it past a certified financial planner or a CPA who has the personal financial specialist designation. Your CPA may be a great guy, but unless he’s had training in financial planning, he may not be a great choice for comprehensive financial advice.

IRA distribution could go into Roth

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Dear Liz: You recently answered a reader who wondered whether he could delay mandatory distributions from his traditional IRA because he was still working. You said correctly that he could delay taking required minimum distributions from a 401(k) but not an IRA. But as long as the questioner is working full time and meets the other tests, he could contribute to a Roth IRA. That would allow him to re-invest part or all of the required distribution. Tax would have to be paid on the distribution, but the money could continue to be invested in an account that isn’t taxed on the earnings annually.

Answer: That’s an excellent point. Withdrawals from IRAs, SEPs, SIMPLE IRAs and SARSEPS typically must begin after age 701/2. The required minimum distribution each year is calculated by dividing the IRA account balance as of Dec. 31 of the prior year by the applicable distribution period or life expectancy. (Tables for calculating these figures can be found in Appendix C of IRS Publication 590, Individual Retirement Arrangements.)

Anyone who has earned income, however, may still contribute to a Roth IRA even after mandatory withdrawals have begun, as long as he or she doesn’t earn too much. (The ability to contribute to a Roth begins to phase out once modified adjusted gross income exceeds $112,000 for singles and $178,000 for married couples.) There are no required minimum distribution rules for Roth IRAs during the owner’s lifetime. As you noted, the contributor still has to pay tax on the withdrawal, but in a Roth IRA it could continue to grow tax free.

Want to know more about Roths? Check out these links

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Nearly 150 bloggers so far have contributed posts to the Roth IRA Movement, which financial planner Jeff Rose organized after speaking to a group of college seniors and discovering none of them knew what a Roth was, or how important it was to their financial futures. (It’s “the best thing since sliced bread,” and really, really important, as you can read in my post “Young and broke? Open a Roth.”)

You can read Jeff’s post here, which is also where you’ll find links to the other 146 (so far) posts. That’s probably more about Roths than anyone can absorb, so here are a few good ones to start with:

Studenomics: “Read This if You Want to Retire Before 70.” An excellent, clear guide to why it’s so important to contribute to a Roth while you’re young.

House of Rose: “I Opened My First IRA Account. Age 22.” The blogger’s personal story of early enlightenment.

Parenting Family Money: “Opening a Roth IRA for a Child.” An early start is good; an even earlier start is better.

Bible Money Matters: “10 Reasons Why I Love The Roth IRA (And Why You Should Too).” If this doesn’t convert you to the wisdom of a Roth, what will?

Amateur Asset Allocator: “Roth IRA: How Do I Love Thee? Let Me Count the Ways.” This blogger wrote a sonnet. Seriously. You must read this.

Lauren Lyons Cole: “How To Pay Taxes Like the Rich.” Why has no one given financial planner Lauren Lyons Cole her own TV show yet? She’s delightful, and hits the highlights of the Roth in a two-minute video.

Please share these links with your friends and anyone you know who isn’t already contributing to a Roth. Help us get the word out about this wonderful vehicle for future financial independence.

Young and broke? Open a Roth

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You young’uns, listen up. Roth IRAs are the best thing since sliced bread. And the best time to contribute is when you’re young and broke, since you won’t always be that way.

Here’s the deal: contributions to a Roth don’t give you a tax break up front. But when you aren’t making much money, you aren’t paying much in taxes, so that’s an easy sacrifice to make.

The beauty of the Roth is when you take the money out. You can always withdraw your contributions without paying income taxes or penalty on the cash. But I recommend you don’t, because if you leave your Roth alone, those contributions—and all the lovely gains they’ll earn over the years—can be withdrawn entirely tax free.

Chances are, your tax rate will be higher in the future than it is now. The future you will be blessing the current you for tucking aside all that tax-free wealth. Every $1,000 you contribute in your 20s could grow to $20,000 or more by the time you’re ready to retire. If you’re so rich by then that you don’t need the money, you can pass the account on to your kids, and THEY can pull out money tax free.

That doesn’t mean you should ignore your workplace retirement plan—your 401(k) or 403(b)—especially if it has a match. But if you can possibly tuck some money away in a Roth, you probably should.

Starting one is easy—just about any bank, brokerage firm or mutual fund company under the sun will be happy to take your money. I like Vanguard’s target date retirement funds, since they do all the asset allocation and rebalancing for you, their expenses are dead cheap and you only have to have a $1,000 minimum investment to start a Roth there. (Don’t have $1,000 yet? Start a Roth at a credit union, save up and then transfer the account to Vanguard.)

Even if you aren’t so young anymore, the tax benefits of a Roth make sense if you’re likely to be in the same or higher tax bracket in retirement.

The ability to contribute to a Roth starts to phase out once your modified adjusted gross income exceeds $110,000 if you’re single and $173,000 if you’re married filing jointly.

Making money is a good thing. But I’ll admit to some sadness when hubby and I stopped being able to contribute to our Roths. These accounts really are a great deal.