young, broke & AWESOME!

With tax season in full swing, many consider making retirement contributions to an IRA before the April 17th deadline for the 2011 tax year. The whole retirement account thing can be really intimidating so I’m going to give you a more familiar environment to explain your IRA options… a bar. If you’re anything like most of my friends, you’re probably a lot more comfortable ordering a drink at a bar than making a contribution to an IRA. When you order a drink, the usual question to follow is if you want to open up a tab. You can pay for the drink now, or you can pay later. Either way, you know you have to pay for it eventually. Well the IRS works the same way with income taxes. You worked? The IRS wants a piece of your income, but with a traditional IRA, you put it on your tab and tell the IRS you’ll pay it in retirement, when you start to take the money out. With a Roth IRA, you pay the tax bill up front. Why would you want to do that, you ask? Plenty of reasons… 1) You never have to pay taxes on that money again. Ever. Even when you pass, your heirs won’t have to pay income taxes on money distributed from a Roth IRA. When you put it on your tab with a traditional IRA, you or your heirs have to pay the taxes eventually. 2) You think you will earn significantly more in the future. If you’re still in the “paying dues” phase of your career, and stand to make a chunk of change more once you have, it makes sense to pay up front when you’re in a lower tax bracket. 3) You’re in school. You will probably never be poorer than when you are a student, which also means you’ll probably never be in a lower tax bracket. If you worked and have the money to make a retirement contribution, pay the IRS now and enjoy the fruits of your labor tax-free in retirement. Besides paying your tax bill upfront, the Roth IRA has some other tricks its traditional counterpart can’t do. - contributions can be withdrawn without paying taxes or penalties. If you contribute $5000 to a Roth IRA and it goes up to $6000 because you are an investing rock star, you can still take out that $5000 without consequences. Why? You already paid your taxes. That money is as good as yours if you want it back. Not so for that other $1000, unless you wait until retirement. -you can withdraw your entire account balance (meaning the whole $6000) with no consequences under certain situations like buying a first home or higher education expenses if the account was opened 5 or more tax years ago. -you can convert traditional IRAs to Roth IRAs. This makes sense when your income drops or if you go back to school. Whenever you have a significant drop in income, there’s an opportunity to pay the tax man at a lower rate by converting to a Roth. There are income limits for Roth contributions, but only if you’re in the 6-digit range or file taxes married filing separate. You can open a Roth IRA at many commercial banks, and online at firms like Vanguard, Fidelity, TD Ameritrade, Schwab and others. Accounts are usually free to open, but certain minimums and trading fees may apply. Haven’t quenched your thirst for Roth IRAs? Check out articles from other personal finance bloggers who are participating in the Roth IRA movement!