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Get your Roth IRA ducks in a row

By Dian Vujovich

Given that we’re still in the first quarter of the year–a time when Uncle Sam and retirement planning can reach their zenith in garnering attention and interest—making sure you understand the ins and outs of traditional and Roth IRAs is a must.

Earlier this month Morningstar’s Christine Benz published an educational piece titled, “20 IRA Mistakes to Avoid” that’s worth a read particularly since IRAs are America’s favorite retirement investment product choice. And, as of the end of the third quarter 2014, assets in them totaled over $7.3 trillion, according to data from the Investment Company Institute.

That’s a lot of green.

Something time teaches us all, however, is that wherever there’s plenty of money flowing in, there is plenty of room for errors of one sort or another.

In an effort to keep you out of the woods and away from easy-to-make mistakes, I’ve selected four points from Morningstar’s piece that specifically address Roth IRAs. Here they are:

• “Assuming Roth Contributions Are Always Best.
Investors have heard so much about the virtues of Roth IRAs–tax-free compounding and withdrawals, no mandatory withdrawals in retirement–that they might assume that funding a Roth instead of a Traditional IRA is always the right answer. It’s not. For investors who can deduct their Traditional IRA contribution on their taxes–their income must fall below the limits outlined here–and who haven’t yet save much for retirement, a Traditional deductible IRA may, in fact, be the better answer. That’s because their in-retirement tax rate is apt to be lower than it is when they make the contribution, so the tax break is more valuable to them now. “
•”Thinking of It As an Either/Or Decision.
Deciding whether to contribute to a Roth or Traditional IRA depends on your tax bracket today versus where it will be in retirement. If you have no idea, it’s reasonable to split the difference: Invest half of your contribution in a Traditional IRA (deductible now, taxable in retirement) and steer the other half to a Roth (aftertax dollars in, tax-free on the way out). “

• “Making a Nondeductible IRA Contribution for the Long Haul.
If you earn too much to contribute to a Roth IRA, you also earn too much to make a Traditional IRA contribution that’s deductible on your tax return. The only option open to taxpayers at all income levels is a Traditional nondeductible IRA. While investing in such an account and leaving it there might make sense in a few instances, investors subject themselves to two big drawbacks: required minimum distributions and ordinary income tax on withdrawals. The main virtue of a Traditional nondeductible IRA, in my view, is as a conduit to a Roth IRA via the “backdoor Roth IRA maneuver.” The investor simply makes a contribution to a nondeductible IRA and then converts those monies to a Roth shortly thereafter. (No income limits apply to conversions.) “

•”Not Contributing Later in Life.
True, investors can’t make Traditional IRA contributions post-age 70 1/2. They can, however, make Roth contributions, assuming they or their spouse have enough earned income (from working, not from Social Security or their portfolios) to cover the amount of their contribution. Making Roth IRA contributions later in life can be particularly attractive for investors who don’t expect to need the money in their own retirements but instead plan to pass it on to their heirs, who in turn will be able to take tax-free withdrawals. “

Read the entire article at: http://tinyurl.com/nasxndl

To read more articles, please visit the column archive.

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