Roth IRA Benefits: Part 1
January 25, 2019
What is a Roth IRA and why does everyone keep making a big deal about it?
One simple answer is, it lowers your taxable income year to year, it allows you to invest in a retirement account BEYOND your 401k limits and it has post-tax benefits.
Alrighty, so, let’s dive in.
The 1st Benefit: Roth IRA contributions will lower your taxable income. Currently there are 7 income tax brackets, check it out for yourself. If you haven’t explored what your taxable income means, think of it this way. Your annual income from all jobs, minus your retirement contributions that year, minus your interest paid on your mortgage, minus your medical bills = your taxable income.
The “accounting” part of this can get tricky. If you are self-employed there are “write offs”, like gasoline and various business expenses that will be factored into lowering your taxable income. Check out a CPA for that.
Getting back into it now, the lower your taxable income, the lower the IRS will “charge” you at the end of every year. Remember that if you are a W2 employee, there has been money “with-held” every paycheck for federal and income taxes that you will have to pay every year. So the money the government takes out of your paychecks goes towards your annual taxes that you are required to file by April every year. It’s like, paying in advance.
In 2019, the 401k limit contribution is $19,000. So during the course of 2019, if you max out your 401k by hitting that $19,000 limit your annual taxable income will be $19,000 less than it would have been. The IRS likes that you are investing money so they give you a break. Once you “max” out your 401k, then what? Consider a Roth IRA. The limit for 2019 is $6,000.
This hypothetical person will have annual contributions of $25,000 towards retirement.
Now, Roth IRA contributions are usually made with your cash. Meaning, your employer pays you and you receive the direct deposit after your taxes, 401k, medical deductions, THEN once your money is in your bank account you would send it to your Roth IRA.
Some might have automatic investing set ups but most individuals contribute to their Roth IRA manually after they get paid. You can invest once a month, once a year, it doesn’t matter. Your total contributions during a calendar year will be considered when you file your taxes the next April. You could invest $500/month for one year or a $6,000/year one-time investment on Dec 15, for example.
My point for this section is, by contributing to your Roth IRA you will be saving money when you file your taxes. If you make $80,000 per year and do not invest into a 401k or Roth IRA, your taxable income would be $80,000 (not considering the automatic deduction and additional deductions). If you make $80,000 per year while maxing out your 401k and Roth IRA, your taxable income would only be $55,000. Less money taxes and more money for your future self!
We so easily allow the IRS to with hold money from our paychecks but we won’t let ourselves with hold money from ourselves! Our thinking is so backwards!