Most people think they’ll be in a lower tax bracket when they retire, but this isn’t always true. And if you make the right financial moves during your working years, it almost certainly won’t be true.

The case for the Roth.

When you stop and consider the many tax breaks you’re likely to lose later in life, you can see why:

Tax breaks you’re likely to lose in, or close to, retirement:

• Deduction of mortgage interest
• Tax deferred 401(k) contributions
• Tax deferred 529 account contributions
• Tax credits for child dependents
• Deduction of Student loan interest

There are many other examples, but you get the idea – you’ll be paying more taxes later in life even if tax rates remained unchanged.

Speaking of tax rates, here’s why tax rates are certain to be higher in the future than they are now:

• The current income tax rates are very low from an historical stand point.
• Federal and State deficits continue to grow at alarming rates.
• The already record Federal deficit is only expected to continue growing for the foreseeable future, as Congress continues to spend money they don’t have.

In addition to paying more taxes, you’ll also have required distributions from 401(k) and similar retirement accounts that may push you into higher tax bracket.

All of this serves as a terrific recommendation for a Roth IRA, because in a Roth IRA, it’s the contributions that are taxed, not the withdrawals. So you’re paying taxes at today’s rates, and when you withdraw your money at a later date, you avoid the crushing tax burden. Also, there are no required distributions, which means if you don’t need the money you can leave it to grow, or leave it to your heirs as an inheritance.

Converting a traditional IRA to a Roth IRA.

You can convert a traditional IRA to a Roth IRA, but there are tax implications and income limitations you should know about. You will owe taxes on the amount you are transferring, so be sure to have cash on hand to pay for the tax bill – if you pay for it out of the IRA balance, you might incur an additional 10% penalty for early withdrawal.

For 2009, you must have a gross adjusted income of less than $100,000 to open a Roth IRA, but those income limits disappear in 2010. So, if your AGI is higher than $100k, it’s best to wait a few months.

A perfect marriage?

Often times discussion about the Roth vs traditional IRA is an either-or proposition, but it may be beneficial to have both.

Here’s why:

You can keep the traditional IRA and open Roth IRA, max out your Roth first, then your traditional IRA. Then, in retirement, you take your mandatory distributions from the traditional IRA as your base income. This is taxed as income, but you can then supplement your income with Roth IRA withdrawals that are tax-free.

This strategy also gives you the flexibility to keep your money in the Roth to continue growing if you don’t really need it as income at that time.

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One Response to “Why Now is a Good Time to Open a Roth IRA.”

1. Business Tax Guru says:

   November 22, 2009 at 10:45 pm

   I’ve been engaged in taxes for lengthier then I care to acknowledge, both on the individualized side (all my working life history!!) and from a legal point of view since satisfying the bar and following up on tax law. I’ve provided a lot of advice and corrected a lot of wrongs, and I must say that what you’ve posted makes impeccable sense. Please uphold the good work – the more individuals know the better they’ll be equipped to cope with the tax man, and that’s what it’s all about.