What is a Roth IRA and Why Should You Care?

I’ve been trying to establish whether there are any restrictions on noncitizens (but legal US residents) having IRA’s. As best I can tell, if you have taxable US income, you can have an IRA…?

@Aaron: I transferred my traditional IRAs to Roth when the Roth IRA was first created in the 1990s. There wasn’t any penalty, I simply had to pay taxes on my contributions, which I was able to spread out over two years if I remember correctly.

@cjohnson: You wrote “I would think that a person with a very long time to invest would more than make up for the future tax liability in a tradition IRA with the investing of the pre tax money.” Your argument is based on the assumption that people will invest less in their Roth IRA because it’s done with after-tax dollars (and thus you have fewer dollars to invest). But given the caps on IRA contributions I think that situation would be quite rare in real life. Most people will set a target for their annual contribution (such as maxing out their IRA, regardless of whether it’s a traditional IRA or a Roth) and save for that. If that’s the way you operate, a Roth makes much more sense than a traditional IRA, because you don’t have to pay any taxes on your earnings. If you have a long time to invest, you’ll have large earnings. Being able to withdraw those tax-free (compared with having to pay taxes on your earnings with a traditional IRA) should weigh the advantage very heavily in favor of the Roth.

@Aaron: Someone else has a target fund program like Fidelity as well, but I don’t recall who.

T. Rowe Price and Vanguard to my knowledge, maybe more. The Vanguard Target Retirement funds are baskets of index funds, which is useful if you favor an indexed rather than managed approach.

JD, a Part 4 with Q&A would be great. I would love to know a bit more about how Socially Responsible Investing (SRI) relates to Roth IRAs.

My recollection, wish I could remember where I read the info. about income limits expiring in 2010, is that there is some fee or tax associated with rolling the traditional IRA into a Roth IRA.

On a somewhat related note, Fidelity (my 401k co.) offers something called a Roth 401k option. I’m putting 1% of my 401k contribution into the Roth 401k which is after tax (not sure how it can be called a 401k if its after tax). I haven’t been able to find much more info about this ’401k Roth’ option. Anyone else know anything about it?

I know many of the questions will be answered in followup posts, so I will add that investors should remember to consider their IRAs as part of their entire retirement savings when balancing and diversifying their portfolio. I.e. A $50k 401k + $10k IRA = $60k retirement portfolio. The funds may be physically separated, but the net effect is that they can still balance each other out for you in the long-run.

I am almost 30 and both my husband and I haven’t opened Roth IRA accounts yet. We also want to buy our first home in the next year. If we have about 20K saved up by the Roth deadline next year, should we use all the money to put toward a down payment, or use some of the money for a down payment, and the rest to contribute (and open) Roth IRA accounts?

This may be a dumb question, but:

If I already have a 401k through work, then why would I want to add a Roth IRA? Wouldn’t it always be better just to contribute more (pre-tax) to the 401k? What other options does the Roth give you that I don’t get with my 401k?

@Kevin: What other options does the Roth give you that I don’t get with my 401k?

a) if you’re maxed out on 401k contributions, a Roth allows you to save an extra $4000/year for retirement. (Subject to the contribution limits.)

b) it lets you choose _exactly_ where your funds are invested — in a 401k you’re limited to the funds offered in your employer’s plan, which may be limited and which may have higher costs.

c) it gives you some tax diversification. In basic terms, the save-now-pay-tax-later structure of a 401k (or traditional IRA) benefits you more if you’re taxed less in retirement than now; the save-and-pay-tax-now structure of a Roth IRA benefits you more if you’re taxed more in retirement than now. Having a mixture lets you hedge your bets, both against future tax rates and against any future legislative changes.

Kevin:

For multiple reasons. The simple one is tax diversification. You don’t know what the tax brackets will look like when you retire. You could be paying less now, or you might pay less then. By having a variety of accounts (some taxed now, some taxed then) you “diversify” yourself so that you aren’t shot in the foot when it does come time to retire.

The Roth also has several nice features such as allowing you to pull money out of it (in certain circumstances)…many more options than 401k or traditional IRAs

Wikipedia has a whole list and a good explanation: http://en.wikipedia.org/wiki/Roth_IRA

Both my husband and I have IRA’s through Vanguard. If you roll a 401(k) or retirement plan directly into an IRA they waive the minimum opening amount. So, I was able to open one with only $1200. NOTE: If you are doing a direct rollover, you MUST roll into a traditional IRA for tax purposes. Then, if you have $5000+ you can roll that IRA into a Roth IRA.

My husband opened his so that he can consolidate 401(k)’s and retirement plans when he takes new jobs. Vanguard has been very helpful. When I have questions, they walk me through everything and even answer questions on different funds (we’re using target retirement funds).

How about information pertaining to SEP IRAs? If I’m a self-employed individual who makes more than the maximum allowable for a Roth IRA wouldn’t a SEP IRA make sense? I’d really like to know more about SEP IRAs, especially how I can set one up with Vanguard, Fidelity or whoever. More pressing for myself, I’d like to know how to transfer one SEP IRA at one institution (my current bank) to another institution (another bank or some other entity) since most places I’ve asked won’t accept my SEP IRA unless I convert it to a Roth, which would mean I could no longer make contributions.

I’m following this series with avid interest. I grew up poor, and spent the first decade of my marriage that way; I never learned anything about investing because I honestly expected to live paycheck-to-paycheck until the day I die. Now years of budgeting, scrimping, and getting an education is paying off, and it’s scary as hell to realize that I have to start thinking about this stuff and I don’t know anything.

So, here’s my question. I’m not to this point yet – my savings are small and inconsistent (maybe $200 one month, $20 the next, but always something!). But I will be within a couple of years. Should I start looking for a financial institution that offers an IRA I like, and move my general savings to them, so that when I’m ready to start investing I have an account history? Or is there no benefit to keeping everything in one bank?

T.Rowe Price has a GREAT option for a Roth IRA.

To begin with, they have a pretty competitive set of retirement funds that are on a par with what you get from Vanguard. The expense ratio is higher (around .76%) but still acceptable, AND you get diversified across some really outstanding mutual funds for the money. (NOTE: I myself invest in their TRRDX, which is their Retirement 2040 fund.)

The other great thing is you can open your T.Rowe Price Roth IRA with $50 so long as you make a monthly systematic automatic investment of at least $50. They also waive small account fees when you make automatic investments each month.

I can’t tell you if this option is right for you, but I think if you’re looking for a Roth IRA this is a good one to check out.
DB

i have a question that always bugs me (I’m 32 yrs old), and not a US citizen, and i probably will only stay in the US for the period i work here (8-10 years).

Do you guys saving in IRA will still benefit me ?? considering that i will no longer in US when i reach 59 yrs old.

Please study IRA and taxes for yourself, and also seek professional advice when needed. Not all the information here is necessarily complete or correct for your situation. Promoting participation in IRAs is laudable, but IRS Publication 590 is over 100 pages long. A few paragraphs and some bullet points are NOT all the information you may need.

On a similar subject, when an investment advisor tells you that he is prohibited from giving legal or tax advice, believe him. I’ve been told things by non-specialists which clearly conflict with information in the IRS publications. Get your professional advice from those with the correct professional standing for the kind of answers you need.

Another question about IRA / ROTH IRA / 401k /any other retirement investment account:

1. Is there any tax on capital gain / dividend distribution that we have to declare on tax return every year ?

2. I was reading Kiyosaki book about his prediction that in the future when most of the baby boomer/older people start cashing out their 401k/IRA/retirement account (by selling their investment), there’s a chance that market will be affected due to supply & demand rules ?
(price might go down since too many people selling their investment & when price keeps going down people stay away form stock market, this can be a scary situation -> the big bust ??)
i know, nobody can predict the future, but do you think his argument make any sense ?

i’m a noob so please enlighten me on this case

Just wanted to second DC Economist’s suggestion. Non-ROTH solutions?

@Rakheem: You asked “1. Is there any tax on capital gain / dividend distribution that we have to declare on tax return every year?”

No, you don’t (unless my three accountants over the last 10 years were all doing it wrong!)

You asked “3. for Roth IRA, is there really NO TAX at all when we start to withdraw from the account? no income tax? no capital gain/dividend distribution tax?”

The language I’ve seen from IRS implies that some states may impose income tax when you withdraw, but my understanding is that you don’t have to pay any federal income tax when you withdraw — and that applies to both your contributions and earnings, which is awesome.