The ROTH IRA is arguably one of the most tax beneficial instruments to individuals for retirement planning. The ROTH IRA, originally called the IRA Plus, was proposed by Senators Bob Packwood and Senator William Roth back in 1997. It was created to do the opposite of typical retirement plans including 401K, 403-B, Traditional IRA, etc. ROTH contributions are taxed in the year earned, but the growth going forward is tax free. Compared to that of a traditional retirement plan where contributors get the deduction off income taxes for the year earned but must pay taxes on both contributions and the growth when funds are taken out. Let’s take a look at an example to illustrate how it really plays out.
Fred and Barney were best friends and planning on retiring at the same time in 20 years when they reached age 60. They both received a bonus of $5,500 and wanted to put it back and grow a nest egg for retirement. Fred wanted to put his money into his traditional retirement plan and was excited that he would not have to pay taxes on his money for that year. Barney, on the other hand, decided to go ahead and pay Uncle Sam now and take the tax-free money at retirement. After 20 years had passed, Barney came out on top because all the growth in his ROTH retirement account was tax-free and ultimately payed less taxes then Fred.
|Traditional IRA, 401K, or 403-B
|Contributions for 2019||$5,500||$5,500|
|Added Federal Tax refund for 2019 (22% taxes bracket)||$1,210||0|
|Amount in 2039||$22,300.61||$22,300.61|
|Taxes owed (22% tax bracket)||$4,906.13||$0|
|How much goes in your pocket||$17, 394.48||$22,300.61|