A Flexible IRA for Beginning Investors

A Message from Kimberly Clouse, Financial Expert:

kim_clouse I have worked in the financial services industry for nearly a decade in many capacities, most recently as a financial adviser for individuals. Over the course of my career, I have had the privilege of working with a diverse range of people, from the single mother just starting her own business to the dot.com billionaire. Based upon my experiences, I have learned that the same basic principles and lessons apply to a successful and healthy financial life, whether you’re starting out or cashing out. These guiding principles include simplicity, a long-term perspective, and above all, knowing that you have control of your financial destiny, and all the information you need is well within your reach.


A Flexible IRA for Beginning Investors

Sound financial planning strategies include setting aside 3-6 months of cash in an emergency account and investing as early as possible during one’s lifetime for retirement. Good advice indeed, but steps that can be difficult to implement for those investors with limited resources. If you are struggling to concurrently create a “rainy day” account and save for retirement, the Roth individual retirement account (IRA) could be an effective solution as it is a much more flexible vehicle than a Traditional IRA.

The Roth IRA allows you to make non-deductible, after-tax contributions to fund your golden years if you meet certain eligibility requirements. If you and your spouse file a joint tax return and your modified adjusted gross income (AGI) as a couple is $150,000 or less ($95,000 or less if you are single), the IRS allows EACH of you to contribute up to $2,000 annually to a Roth IRA. You do not receive an upfront tax-deduction with a Roth IRA because you will be able to withdraw your monies tax-free later on. (With a Traditional IRA, you enjoy a deduction for your contributions in the year in which you make them if you fall below specific income limits.)

One of the benefits of a Roth IRA is that you can withdraw your original contributions at any time without incurring taxes or penalties. If you and your spouse each contribute $166 per month to your Roth IRA account ($2,000 each per year), after 5 years you will have $20,000 in original contributions, plus any earnings, in your account. If you were faced with an emergency, you could withdraw the $20,000 with which you funded the account without paying taxes or penalties. Compare this provision to that of the Traditional IRA. With a Traditional IRA, most account holders incur a hefty 10% penalty if they withdraw any monies–contributions or earnings–before age 59½. (Other benefits of the Roth include no mandatory annual distribution requirements and the ability to make contributions beyond age 70½. With a Traditional IRA, you must begin making withdrawals by the year after you reach 70½ or face penalties.)

The restrictions on a Roth IRA are stricter for the earnings generated on your contributions, which include dividends, interest, and capital gains. All contributions and earnings in your Roth IRA account can be withdrawn tax and penalty-free after your Roth IRA account has been open for at least 5 years and after age 59½, and in the event of specific circumstances, including disability and to make certain home purchases. If you do not meet these requirements, then you will pay a penalty to withdraw your earnings. In any case, you can always withdraw your original contributions.

In general, beginning investors tend be cautious of Traditional IRAs because of the prohibitive penalties that they would incur should they need to access their funds prior to age 59½. The Roth IRA, on the other hand, can be the optimal solution for investors trying to provide a cushion for today and tomorrow.

This column is designed to provide accurate and authoritative information on the subject of personal finances. It is provided with the understanding that the Author is not engaged in rendering legal, accounting, or other professional services by publishing this column. As each individual situation is unique, questions relevant to personal finances and specific to the individual should be addressed to an appropriate professional to ensure that the situation has been evaluated carefully and appropriately. The Author specifically disclaims any liability, loss or risk which is incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this work.