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{ 51 comments… read them below or add one }

Mike @Personal Finance Beat January 14, 2013 at 9:40 am

Nice, detailed post. Currently I have my work 401k, and a brokerage account — where I invest mostly in dividend-paying stocks. I have been thinking about stopping the brokerage account contributions, and opening up a Roth instead. Being able to withdraw your contributions without any penalty is huge! And, obviously, that the gains are tax free.

Do you think that is the right way to go, Roth >>> brokerage? I’m trying to think of any downside …

-Mike

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retirebyforty January 14, 2013 at 2:33 pm

If your main goal is to save for retirement, then Roth is the way to go. With a taxable account, you’ll be paying tax on the dividend every year. If you are saving for a big purchase like a vacation or a wedding, then a taxable account will be easier.

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papadad January 16, 2013 at 11:33 pm

@ RB40 you need to ensure to include that you must have EARNED income equal to the amount that you wish to contribute to a Roth IRA.

@mike I would never dump all my eggs into the 401K/IRA basket. Government can change taxation rules, withdraw rules etc and leave you in a precarious position.

I would always keep some in a regular “get to it no matter what” cash account…. the tax differential may be significant but offset that with the security of being able to access when needed…. just food for thought. Diversification rules apply.

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RichUncle EL January 14, 2013 at 9:41 am

I funded my first Roth IRA when I was 19. I wanted to buy stocks and the investment advisor told me he was amazed by what I was doing but then steered me to do the IRA. I am happy I got such good advice from him.

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retirebyforty January 14, 2013 at 2:34 pm

That’s great! We are planning to teach our kid about investment at a young age also. Hopefully he’ll have earned income by 19 and able to open a Roth IRA.

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JoeTaxpayer January 14, 2013 at 8:24 pm

19? My 14 year old has been depositing to Roth since 2010. Babysitting brings in some big bucks in our neighborhood.

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retirebyforty January 15, 2013 at 2:26 pm

14 is awesome. I gotta push my kid to make some money. :)

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papadad January 16, 2013 at 11:45 pm

licking and stuffing envelopes is essential to running a successful real estate rental business (hint hint) and fun for 2 year olds too… and great way to help the Baby RB40 earn some income and start their roth really early…. Something to think about…

My Financial Independence Journey January 14, 2013 at 5:34 pm

If you’re planning to retire early, accounts that lock your money away until you’re 60 are probably not the best idea. Early retirement requires heavy investment in taxable accounts assuming that you’re planning to live off of your investment income.

401K matches offer enough incentive for me to invest in them up to the match, but otherwise I remain nonplussed.

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retirebyforty January 15, 2013 at 2:22 pm

That’s a good point. I still would like to have a big retirement fund though.

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Rose January 5, 2014 at 3:39 pm

NO! Rule of 72T, or Substantially Equal Periodic Payments, states that you can tap your retirement funds at an annutized rate without penalty at basically any age, for the minimum of 5 years or until 59.5, whatever is greater: http://www.investopedia.com/terms/r/rule72t.asp Anyone who is looking to retire early MUST know about this. It allows you all the advantages of tax deferred/free investing without penalty. Best of all, If I have understood it properly, you can apply SEPP to one of your IRAs, and not necessarily all of them.

I will be 52 when we retire in full, and will be pulling from regular IRAs to fund early retirement, keeping SS untouched until 70. The funds that I put in at a high tax base will be pulled at a very low tax base, and then put into taxable accounts, or converted to Roths. The point is to pay as little tax as possible so that more of your funds can stay with you for retirement, as well as to minimize future taxable distributions when taking SS so that your SS checks will not be taxed. So much of what the gov’t uses to decide if you are eligible for “aid” or responsible for taxes is based on income, not assets.

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Rose January 5, 2014 at 4:39 pm

OK. Not really sure how I got a thread started in early 2013 sent to my email for early 2014, but maybe someone will benefit.

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retirebyforty January 6, 2014 at 12:19 am

I’m reposting some articles and I need to figure out how to stop it from sending the emails. Thanks for your input. I’m sure it will be helpful for some readers.

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JoeTaxpayer January 14, 2013 at 8:22 pm

Keep in mind that retiring 100% Roth is a lost opportunity. In 2012, exemptions and the standard deduction for a couple adds to $19,500.
This means a couple with $487,500 (can we say $500K?) withdrawing 4% of the account value each year can take their withdrawal from a Traditional pretax IRA and pay no tax. For those in the 25% bracket while working, it would be a shame to get so excited about tax free Roth accounts that they miss this.
But – to add to your point, the impact of social security taxation can force the above numbers down a bit, and using the Roth to keep those withdrawals below $20,000/yr before taking social security payments is advised.

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retirebyforty January 15, 2013 at 2:26 pm

Sure, but it’s not any fun to live on $20,000 per year. I assume most people would like to have a comfortable $50,000 income in retirement. That’s pretty close to the 25% tax rate. I’ll have to reread your social security taxation article again. I forgot most of it already. :(

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Chris January 15, 2013 at 7:17 pm

Likewise, currently $33,630 taxable amount would receive a tax of only $3,630 getting you to the $30,000. So, if you get to $1M, the person would be able to hit the $50k/yr withdrawal for 40-50 years without having a worry about running out, and paying the taxes in the 15% (after the standard deduction of $20,000 as a couple.

Technically speaking, they could withdraw $60,000/yr paying taxes and after 50 years they would just be about $0 in the account at the end of that time.

OK, I just talked myself into figuring out how to get my accounts up to $1.25M! :-)

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JoeTaxpayer January 15, 2013 at 9:30 pm

RTF & Chris –
If I wasn’t clear, I agree on the merits of Roth. Ideally, if the couple retires with $500K pretax, and the rest in a Roth, they will minimize their tax bill.
Chris – the way that Social Security becomes taxed creates an effectively higher set of brackets, a single retiree paying 46% while still withdrawing little enough to think she should be in the 15% bracket. This is the least understood bit of finance for most people. For how it works, see my 2 articles at Rothmania.net. I produce graphs for both single and couple, and show the assumptions I make, i.e. the social security benefit, etc. A couple hits 27.5% with 29K or so of income. Yes, I accounted for the std deduction/exemptions, etc. All numbers were produced with tax software.

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Sarah Park January 15, 2013 at 12:16 am

I didn’t have any idea about Roth IRA. This post is a big help.

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retirebyforty January 15, 2013 at 2:27 pm

I’m glad to hear that. Let me know if I can answer any question.

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papadad January 16, 2013 at 11:36 pm

Good article on top questions….from motley fool :

http://www.fool.com/Money/AllAboutIRAs/allaboutiras09.htm

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JoeTaxpayer January 17, 2013 at 8:29 pm

Nice enough article you linked to. One note, the rule regarding AGI throttling one’s ability to convert a TIRA to Roth has been eliminated. Anyone can convert if they wish, regardless of income.

The tax laws change so quickly, it’s important to look at the date an article is published. In my own writing, I frequently mention the year and “this is for 20xx,” check the IRS web site or other media for updates.

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Mike January 15, 2013 at 4:02 am

I think a Roth might be a small part of a wiser strategy if you know how to create other places for money. But it looks good never the less.

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Julio January 15, 2013 at 4:44 am

Can I deduct the Roth IRA in my Tax Returns?

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retirebyforty January 15, 2013 at 2:27 pm

No, you can NOT deduct the Roth IRA in your tax return. The big benefit is you don’t have to pay tax on the gain later.

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Fi Fighter January 15, 2013 at 8:03 am

Getting started early and investing in a Roth IRA was probably the single best financial decision I ever made. It’s an absolute joy watching the portfolio grow and compound over time. It’s even better knowing that the gains aren’t subject to more taxation later, so just sit back and watch it multiply! Oh, and of course, keep contributing to the max each year if you can.

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retirebyforty January 15, 2013 at 2:28 pm

My Roth didn’t do well because I took on too much risk, but I’m adding to it. It’s a slow process.

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Terah@The Credit Report Chick January 15, 2013 at 8:32 am

I love my ROTH IRA and its one of the best financial decisions I’ve ever made. I only regret that I didn’t start earlier in life.

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SavvyFinancialLatina January 15, 2013 at 1:35 pm

I started my ROTH IRA in 2012. Invested in $3,000 in a Vanguard fund.
We still have to fund my husband’s. I’m not sure if we are going to fund our ROTH IRA(s) this year. First we save for the down payment of a house, if we save above that amount, I will put it into the ROTH. Here’s to hoping.

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retirebyforty January 15, 2013 at 2:30 pm

Good luck! It’s hard to prioritize when you are young. I hope you can save up for a down payment soon and find a nice home.

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Financial Samurai January 17, 2013 at 8:21 am

My only fear (besides paying taxes up front) is that folks who have no idea about investing trade like a maniac and blow themselves up.

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Rose January 5, 2014 at 4:35 pm

MMMM, I also fear a value added tax, or essentially a federal sales tax. That would be one way to tax a Roth, and all retirement accounts.

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Patrick January 19, 2013 at 7:17 am

I’m 42 ,single,and have no 401k or IRA.
I currently make $45k a year.Have no debt and want to put as much as i can into retirement. I know i am starting way late but……

What would be the best thing to do currently.
I’m all for setting up an acct with First Trade or any similar Company.
Thanks.

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retirebyforty January 19, 2013 at 11:07 pm

You should see if your workplace has a 401k plan. If your employer match your contribution, I would invest there first.
Once you take full advantage of the employer contribution, then you probably should invest in the Roth IRA next.
Good luck! It’s never too late to start saving.

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Dave March 10, 2013 at 10:51 am

Here is my question and help would be appreciated. I am 40 and have continued to contribute the max to my traditional IRA since 1996. The value is currently 100,000.00 and I am wondering if I should stop contributing the max to the traditional IRA and instead start over with a Roth IRA and contribute the max to it each year. Here is the golden question, would it be worth missing out on the compounding effect of not contributing to the traditional IRA which currently has nice balance to instead reap the benefits of tax free investing in the Roth IRA? I am not interested in a conversion because of the tax consequences I would have to face at the time of the conversion. This is a good math problem for someone out there. Thanks and any help would be nice.

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Andrea May 4, 2013 at 10:16 pm

I’m late too so I don’t know if this will be seen but here goes.

I am about to get 10,000 dollars I never expected to get so I wanted to open a ROTH IRA and place it in there because I already have about 112,000 in my liquid savings. Can I place 10,000 dollars in a ROTH to start? I am confused by the limits you can contribute. Can you contribute ANY amount into it when you open it?

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retirebyforty May 4, 2013 at 11:30 pm

Hi Andrea,
There is a yearly cap and you can only contribute $5,500 in 2013 (assuming you are under 50.)
Open an account and place $5,500 to start. Save the rest in your saving account and add to the Roth IRA next year.
Hope this helps.

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Dave May 31, 2013 at 3:34 pm

I’m 23 and just recently started learning about the value of saving for my retirement, but I’m really confused on what exactly I should be doing. I want to start contributing to a Roth IRA, but what differentiates a good and bad company to work with?

Any pointers or links you could give me would be greatly appreciated!

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retirebyforty June 1, 2013 at 2:57 pm

Hi Dave,
It’s great that you are starting now. Investing takes a long time to learn and the earlier you start, the better. You’ll make some mistakes, but you will learn from it. My advice is to see how the finance company you work with get paid.
Many financial advisors are just salesman trying to sell you something. I suggest you try self directed investing first and see if you like it. Most online brokerage are very similar and affordable.
I think Firstrade and Scottrade are two with very low fees. You should try them and see if you like them. You can always change broker. It’s not a big deal. The most important thing is to start investing ASAP.
You probably should start with Vanguard funds.

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Rob October 23, 2013 at 5:59 am

Great piece! I’m 37 and we don’t qualify to contribute to a traditional Roth due to income limit. However, my company offers a Roth 401k. I currently split my 12% that I’m allowed to contribute annually: 7% 401K and 5% Roth 401k. I’m wondering if I should go all Roth, but my thought was I would get my taxable income lowered by contributing to the 401k vs Roth.

Many thanks!

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retirebyforty October 23, 2013 at 6:30 am

That’s a tough question. Do you want to pay tax now or later? I tried contributing 100% to Roth 401k for a couple of years, but I hated paying all that extra tax so I went back to traditional. You might want to talk to your tax guy to see if he/she has any advice.
Currently, Mrs. RB40 is splitting her traditional/Roth 401(k) contribution.

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Green Money Stream January 5, 2014 at 3:01 pm

This is a great detailed post. Opening a Roth IRA has been on my to do list for a while. We are over the income limit for a traditional IRA and currently I’ve been investing in a taxable account. I’d like to balance things out a bit with a Roth IRA.

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retirebyforty January 5, 2014 at 11:55 pm

The income limit went up a tiny bit this year. You might want to check.

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Kayngi January 5, 2014 at 9:32 pm

It’s so nice to see such great retirement advice! I really appreciate it.

I do have what I suspect is a dumb question. Your article talked about starting a Roth IRA and then about investing in stocks. I thought that you just put money into the IRA and let it compound. Can you invest in stocks through the IRA? I’m confused…

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retirebyforty January 6, 2014 at 12:07 am

You need to invest the money you put in the Roth IRA. You can invest in stocks, bonds, or anything you’d like. You don’t want to just deposit the money and let it sit there. Good luck!

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Laurie January 6, 2014 at 4:42 am

Actually, you do not have to pay any transaction fees for no-load mutual fund investing. I have invested for years in Vanguard funds via the Vanguard site, and I pay no transaction fees for mutual fund transactions. The same is true for Schwab; I pay no transaction fees to Schwab when I invest in mutual funds via their site. All of the mutual funds I invest in via both companies are no-load. You will need to compare fund-by-fund to see if the ones you are interested in are available, but it is definitely worth checking as these transaction fees really add up if you are dollar-cost averaging.

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RetireAtSomePoint January 6, 2014 at 9:19 am

Hello,

I contributed my limit of $5,500 last year but found out from my accountant that I was unable to contribute since my gross income was above $110,000. As a result I had to remove what I contributed plus any gains, then pay taxes on the gains. I’m not sure what my gross income will be at the end of this year, but I’m afraid to contribute since I might have to withdraw again. She advised me to convert my RothIRA to a traditional IRA. Is this a good move? I’d like to keep it, but if I can’t contribute to it, what’s the point?

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retirebyforty January 6, 2014 at 3:53 pm

Yeah, if your income is over the limit, then you probably shouldn’t put money in the Roth IRA. We stopped contributing when we were over the limit.
I’m not sure why you would convert Roth IRA to traditional IRA. What’s the advantage?
You can try contributing to the Roth 401k. That might work if it’s available.

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RetireAtSomePoint January 8, 2014 at 1:44 pm

Doesn’t a traditional IRA have different income limits? Wouldn’t it make sense to convert it to a different type of investment so I can contribute to it instead of just letting it sit there? I just want to be able to contribute to it regardless of my income.

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retirebyforty January 9, 2014 at 3:15 pm

Actually, I think it depends on whether you have a retirement plan at work or not. If you do, then the income limits is similar. I think the Roth IRA have a higher income limit. Please check with a tax professional and research the IRS site.
Even if you can’t contribute to the Roth IRA, I think it’s still a good idea to keep it. You can always open another traditional IRA. You don’t have to convert your Roth IRA. Your situation can change in the future and you might be able to add contribution later.
Good luck!

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wallet engineer #1 January 7, 2014 at 9:51 am

I would note that a fund with a low expense ratio is necessary or you are throwing away money. IVV does very well in this regard.
My preference is Vanguard, specifically VTSMX .

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Broke Millennial January 7, 2014 at 6:41 pm

This is really awesome! I’ve been eying a Roth IRA as my next investment adventure (full disclosure I actually do have a Roth 401k). This breakdown is going to be really beneficial as I start vetting my options.

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