The Roth IRA

The Roth Individual Retirement Account was created by an act of Congress. The Roth allows for post tax contributions that can be invested in a number of ways, the most common being mutual funds and stocks. Almost any financial institution provides Roth IRA accounts. Banks, brokerage houses, and insurance companies offer certificates of deposits, money markets accounts, mutual funds, and stocks. Considering the long term outlook of most Roth Investors (the funds cannot be accessed tax free until age 59.5), it probably doesn't make much sense for Roth account holders to invest their dollars into anything other than stocks and mutual funds that have a reasonable amount of risk and reward potential.

Contributions to a Roth are made post-tax, therefore, unlike a Regular IRA, contributions to a Roth are not deductible on your tax return. The advantage is that withdraws from a Roth, so long as they qualified, are completely tax-free. Qualified withdraws include those made after age 59.5, up to $10,000 for the purchase your first house, or if you become disabled. A Roth IRA effectively allows you to prepay a future tax liability at a tremendous discount. This is true for two reasons:

First, taxes in the future will very likely be higher than they are now. As the population ages, and there is a smaller percentage of people in the workforce, but a greater demand made on the government for services to support the aging, taxes will need to be increased to pay for this increased demand and lowered supply. Think of the welfare states of Western Europe. Their taxes are a much higher percentage of income. They offer more services, like free health care for all, have greater unemployment, and have a larger percentage of elderly and retired citizens.

Second, the money you invest now in a Roth IRA will grow and you will experience compound returns, so if you're 30 years old and make a $5,000 contribution in 2008 that you have already paid taxes on, when you withdraw that money at age 60, that same $5,000 is now worth $66,338 (30 years at average 9% return per year). Further, even at a 25% tax rate (and believe me the tax rates in 30 years will be higher, not the same and definitely not lower than they are now) that $66,338 is effective worth the same amount as earned taxable income of $88,459. But you paid taxes on $5,000! And at a lower rate!

Beginning in 2008, Congress has allowed contributions of up to $5,000 for taxpayer’s age 49 and younger, and $6,000 for taxpayers age 50 and older. After 2008, contribution limits will be indexed with inflation and raised at $500 intervals. There was a lot of talk for years in the financial services industry that the Roth was too good to be true, and that Congress would eventually be forced to close this opportunity to taxpayers. That has not happened yet, but most Americans do not take advantage of this powerful tool. As both the Roth IRA and the Roth 401k gain in popularity and the pool of taxable income continues to shrink, it's anybodies guess what the future holds.