Should I Set Up a Roth IRA?

Feb 1 / Matt Gray, CFP®
A Roth IRA is a type of investment account that you don’t ever pay taxes on once you’ve put money into it. As with anything, there are exceptions to the rule, but the Roth IRA can be an extremely powerful tool when it comes to your finances.

You might be thinking that if it is such a powerful tool that everyone should have one and put tons of money in! That would be a great idea but it doesn’t make sense for every situation and there are limits to how much you can put in. These limits occasionally change but sit at $6500 per year at the time of this writing.
The first consideration is whether you are contributing to your 401K plan. Many 401Ks offer a Roth option AND have an employer match. You should almost always be contributing to this option first if it is available to you, regardless of income.

The second consideration is whether you qualify to use a Roth IRA and that generally depends on your income and tax filing status. You must have EARNED income to contribute as opposed to your gap year when you lived off savings. Those savings you spent don’t count as earned income.
Additionally, you can be disqualified from making contributions if you make too much money. These income limits vary year by year but are solidly into upper middle class with individual filers needing to make more than $153K and couples more then $228K to be fully disqualified. You are also disqualified if you are married filing separately.

Congrats if you make more than the income limit! I also suppose a consolation congrats is in order for those that make less because you can get a Roth IRA. Those that make more than the limit may consider a Backdoor Roth Conversion.

So far you are contributing to your 401K, make less than the income limit, aren’t filing separately, and have some extra CASH on hand (WOOT WOOT!). Should you contribute to your Roth IRA or do something else with it?

Here are some reasons you SHOULD open and/or contribute to your Roth IRA:
  • You are currently in a low tax bracket or lower than the one you expect to be in later
  • You have extra cash with no major expenses upcoming.
  • You are young.
  • You want to pay less in taxes over your life (I mean, this is kind of tongue in cheek).
  • You want flexibility in accessing some of the money

Taxes are a key component in determining how you manage your finances and it is the same with Roth IRAs. Putting money into a Roth IRA is a great idea if you think your taxes will be higher when you need to use the money. If taxes are 20% today and 30% later, you can save 10% by paying taxes now. It’s simple math, but there is a bit of educating guessing on where taxes will be later with this point. Consider our article on Roth Vs Traditional here to get a bit more detailed insight on this idea.

Holding too much cash is a bit of a financial sin. Using extra cash to fund current or future goals is a much better idea. The importance of the point here about extra cash is that you DO NOT have an upcoming expense. There are ways to access some funds in a Roth IRA but the power of the account is to not touch them. For this reason, only contribute if you don’t have an expense upcoming (car, home, tuition, etc).
Young people get the advantage of long-term tax free growth here. This is about compounding growth of the account and having more years of racking up tax-free dollars. You’ll thank yourself later if you can keep your eyes on the decades-later prize.

A key benefit of Roth IRAs is that you can access some of the money. Any contributions you make can be taken out tax and penalty free (track and document your contributions closely). So if you put $5K into your Roth and it grew to $7K, you can take out $5K with no issues. The other $2K of growth is untouchable until retirement like other retirement accounts.

Most of the reasons not to contribute to a Roth IRA are simply the opposite of the concepts above. You might make too much, be in a high tax bracket, be near retirement, or have upcoming expenses you need the cash for. Either way, you should talk to a financial planner if you are unsure which makes the most sense for you.

Roth IRAs are fantastic accounts for those that qualify and can create a significant source of tax-free income in retirement.

About the Author - Matt Gray is a Childfree Financial Planner who holds both the Certified Financial Planner® designation and the Chartered Advisor of Philanthropy designation. He enjoys working with his Childfree peers because he enjoys helping solve the specific needs of the Childfree community. Furthermore, he believes choosing a less traditional life path leads to more unique life stories and he loves helping those stories become a reality. Matt co-hosts the Childfree Life and Money Podcast with Dr. Jay.