Roth to the Rescue

Introduction to Roth accounts

By Kaye A. Thomas
Updated January 19, 2008

A Roth account can help meet the retirement challenges of the twenty-first century.

They say only death and taxes are certain, but you can avoid one of them. Using a Roth IRA, or a Roth account in a 401k or 403b plan, you can grow your retirement wealth tax-free.

Traditional retirement accounts allow you to delay paying tax, often for many years. That helps the account grow faster, but you'll have taxable income later when you withdraw the money. The more the account grows, the more tax you end up paying. The IRS is a silent partner sharing in your success.

This page is an excerpt from our book Go Roth!

In a Roth account, all the money is working for you. Follow the rules and you'll never pay income tax on the earnings. It's like having a tax haven, except you don't have to deal with a shady outfit that operates out of a post office box on a tropical island.

Opening the door

The Roth revolution began in 1998 with the introduction of the Roth IRA, named for a Delaware senator who pushed for its creation. Changes over the years have gradually made these accounts available to more people:

Beginning in 2005, required minimum distributions don’t count for the income limitation on conversions to Roth IRAs.
Beginning in 2006, income limits for contributions to Roth IRAs are indexed for inflation.
Beginning in 2008, an eligible distribution from a traditional account in an employer plan can be converted directly to a Roth IRA without going first to a traditional IRA.
Beginning in 2010, the $100,000 income limitation on Roth conversions disappears.

Two Roths make a right. The biggest change of all took effect in 2006. Employers can now offer Roth accounts in 401k and 403b plans. These accounts are not exactly the same as Roth IRAs, but they work on the same basic principle. If your company offers this option, you can enter the tax-free world of Roth retirement savings without giving up matching contributions or other advantages of saving in an employer plan.

A timely benefit

The Roth revolution comes at a time of profound change in retirement planning. Several megatrends are converging to shift responsibility for retirement security away from government and employers and onto the shoulders of individual retirees:

People face longer retirements as lifespans increase.
The aging and retirement of the baby boom generation will have major implications for various government programs and for the economy in general.
American businesses are in the midst of a massive shift away from traditional pension plans to plans that pay benefits based on the size of your account balance, such as 401k plans.
The Social Security program is projected to begin collecting less than it pays out in 2017 and, in the absence of changes (tax increases, benefit reductions, or both) it is projected to lose the ability to pay full benefits in 2041.

The new reality: YOYO retirement. In other words, you're on your own. Your financial security is going to depend on the choices you make.

Roth to the rescue

Roth accounts don't solve all these problems, but they can help meet the challenges of YOYO retirement. They offer four main advantages over traditional IRA, 401k and 403b accounts.

First and foremost is the chance to make your investment earnings permanently tax-free. This advantage by itself is often equal to or greater than the benefit of claiming a deduction when you contribute to a traditional retirement account. Second, a Roth account is effectively larger than a traditional retirement account, because all the money is working for you. The IRS doesn't get to share in your success. Third, the minimum distribution rules that apply to traditional IRAs beginning at age 70½ don't apply to Roth IRAs. That means the tax benefits of Roth accounts can be preserved far longer. And fourth, Roth IRA owners can usually withdraw at least some of their money before age 59½ without paying a penalty tax.

Overall, Roth accounts make it easier to build, preserve and use your retirement savings.