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Sandra Gilpatrick, CFP ®,CDFA™

Who should pay attention to Roth IRAs?

Many parents don't realize they can start a custodial Roth IRA if their kids earn reportable income. My 14 year old son had his first summer job as an employee and earned $2300. I helped him start a custodial Roth IRA and he was able to make a $2300 contribution. When he turns 18 in Massachusetts (majority age varies by state), it will become a Roth IRA where he can make the investment & withdrawal decisions. He could contribute as much as he earned up to $6000 in 2022. In 2023, the maximum contribution goes up to $6500. Don't feel bad about not opening one when you had a high school job, Roth IRAs only started in 1997 when the Taxpayer Relief Act passed.

My favorite use for Roth IRAs is for younger people who earn under the income phase out, which starts at $129,000 in 2022 increasing to $138,000 in 2023 for a single tax-filers. Having a number of years ahead of eligibility will help grow the account. I would be less enthusiastic about starting a Roth IRA if the income phase out would be hit in just a year or two. You could be stuck with a smaller account balance at a custodian having to pay an administrative fee to keep the account open. However, if you hold the Roth over five years, the two most common penalty-free (under 59 1/2 year old) uses I see are taking up to $10,000 for a first time home purchase and eligible college expenses (including tuition, fees, books, computer).  A repeated mistake I've seen is contributing to a Roth IRA when you make too much money, so watch the income limit.

Why are Roth IRAs so attractive? If you follow the rules, you receive tax-free distributions later. You don't receive a tax benefit putting the funds in. However, those funds could grow for many years and you'll get the reward of taking tax-free income later and you also don't have to start taking required minimum distributions at age 72. If you are in a low tax bracket, current tax incentives are less appealing. For example, if you are in a 22% tax bracket now, if your tax bracket is higher in the future when you expect to take funds out, you've planned well with a Roth IRA. However, the more money you make, the more attractive current tax deductions may be to help alleviate a higher current income tax. If you are in a high income tax bracket now, you may have a lower income when you stop working in retirement, reducing some appeal of the Roth IRA. Unfortunately, an unknown variable is what tax brackets will be in the future, which is anyone’s guess.

My assessment is younger people with lower incomes expected for a number of years should consider Roth IRAs. Consistently contributing to your retirement plan is also an excellent financial habit to reinforce early. If I could go back in time to tell my teenage self to start investing for retirement, as a 49 year old now, I would be even closer to my financial goals.