Do you have a Roth IRA? If not, you need to get one. 401k plans are great and so are pension plans (if you’re lucky enough to still have one), but I believe the best road to riches for most investors is via the much-celebrated but under-utilized Roth IRA.
Tax-Free Income For Life!
You’ll sometimes hear the above phrase during high-pressure sales pitches on late-night infomercials, or perhaps at one of those “get-rich-quick” seminars. Most people are immediately on their guard when they hear such claims because hey, the only sure things in life are death and taxes, right? Well, yes. But Roth IRAs offer an intriguing tax proposition: tax-free income at retirement. Think how far your income would stretch if you didn’t have to pay income tax on it. You wouldn’t even need to rely on unattainably-high Roth IRA rates of return to generate a large enough pile of capital to generate a modest tax-free income.
What’s The Catch?
There’s always a catch, isn’t there? In this case, the catch is that you’re trading a current tax break for a future tax break. Traditional IRA’s, 401k plans, and the like offer an immediate tax deduction: if you contribute $10,000 to your 401k plan at work, you are also reducing your current taxable income, that is, if you’re in the 25% federal tax bracket you are effectively saving $2,500 in taxes by contributing $10,000 to your 401k.
With a Roth IRA, you pay taxes upfront in exchange for not having to pay any taxes on your gains in retirement. For young investors in a low tax bracket (and likely to be in a higher tax bracket later on in their career and in retirement), a Roth IRA is practically a slam dunk; you’d be a fool not to max out your contributions every year. Even if you expect to be in right about the same tax bracket when you retire, you’re likely to come out ahead in the long run by going with a Roth IRA instead of a 401k, and that’s not even taking into account the fact that congress will likely raise income tax rates eventually.
So if you’re not already contributing to a Roth, what are you waiting for? The Roth IRA deadline isn’t until April 15th, so go max out your contribution for last year and get a head start on this year’s contribution right away!