As working folks get closer to hanging up their spurs, it is easy to become overwhelmed. When should you take Social Security? What type of insurance do you need? Should you buy an annuity? Do you need nursing home insurance? Should you roll over your 401(k) into an IRA? The list goes on and on.
Retirement planning requires many irreversible decisions. We each need to get it right; however, what is right for us is not always right for someone else. And, in addition to basic number-crunching, we each make assumptions about life and politics—sometimes without even realizing it.
One of my most significant personal decisions pertained to a Roth IRA. Managing your traditional or Roth IRA is an ongoing process, no matter how near or far you are from retirement. And the options are worth investigating regardless of the size of your portfolio. Making sure your money lasts requires much more than picking the right stocks. Owning those stocks—or whatever else you invest in—inside the right type of account can grow your portfolio faster and save you thousands of dollars in taxes, if not more.
I’m not shy about seeking out experts in different investment niches. In this spirit, I reached out to Terry Coxon, a senior economist and editor at Casey Research and principal in Passport IRA.
In the spirit of full disclosure, I want to add that Terry has taken the time to mentor me on occasion, and he’s encouraged me to bring some of my vast life experience to our readers. As Terry has reminded me from time to time, math is only part of the retirement puzzle—the uncertainties inherent to politics and the law are also integral pieces.
Terry travels the world, and I was lucky to catch him upon his return from a recent trip to the Cook Islands.
Dennis Miller: Terry, welcome. Many investors use a traditional IRA or retired with a lump sum from their 401(k). Can you tell us how a Roth IRA differs from those plans?
Terry Coxon: With a traditional IRA, if your income isn’t too high, you get a tax deduction for your annual contribution. But later, the money you withdraw is taxable as ordinary income, except to the extent of any non-deductible contributions you made. In the meantime, earnings accumulate without current tax, which helps the money grow much faster.
A Roth IRA is different. With a Roth IRA, you don’t get a tax deduction for your contributions; but all the withdrawals you later make can be tax free. The only requirements for keeping withdrawals 100% tax free are: (a) the Roth IRA must be in at least its fifth calendar year of existence; and (b) you must have reached the calendar year in which you will be at least 59 1/2 years old. As with a traditional IRA, earnings accumulate and compound free of current tax – which is the special power source of any retirement plan.
Most 401(k) accounts are similar to a traditional IRA in that contributions are deductible; withdrawals are taxable; and while they stay inside the account, earnings go untaxed. However, there is a variant called a Roth 401(k) that is available to sole proprietors and to participants in employer plans whose rules provide for Roths. With a Roth 401(k), there is no deduction for money that goes in; the money is invested free of current tax; and everything can be tax-free when it comes out.
