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piggy bank and roth IRA

As one of Dave Ramsey’s Smartvestor Pros, it is common for us to meet clients who have heard Dave talk about using a Roth IRA to save for retirement. Sometimes they have heard Dave talk about this but they don’t completely understand what it is or the “why” behind it.

As Dave Ramsey always says, you should never put money into something that you don’t understand. That is why your Financial Planner should have the “heart of a teacher”. In this article, we will walk you through some of the features of a Roth IRA but it is always best to talk to a Financial Planner about your specific situation.

To be clear, Dave recommends that you hold off on any sort of investing until you complete the first 3 Baby Steps, which are (1) to build a $1,000 starter emergency fund, (2) Pay off all non-mortgage debt using the “debt snowball” and (3) save three to six months of expenses (note expenses, not income) in savings. Dave Ramsey has 7 Baby Steps in total and you can see all of them on his website.

What Is A Roth IRA?

A Roth IRA is a personal retirement savings plan that offers certain tax benefits to encourage retirement savings. What are those tax benefits? Unlike a Traditional IRA, where you are putting in pre-tax dollars, a Roth IRA has the individual contribute after tax dollars. Like a Traditional IRA, the investments inside of a Roth IRA grows tax deferred, but unlike a Traditional IRA, if certain conditions are met, distributions (including both contributions and investment earnings) will be completely tax free at the Federal level.

That’s where the fun comes in – let’s assume, our friend, Sally Client, who is 30 years old has worked the Baby Steps and is now on Baby Steps 4, 5 and 6, thus she is saving 15% of her household income into retirement. Sally’s income is $50,000 and through her company provided 401(K) Plan she’s eligible to receive a 5% match on all contributions. Thus Sally contributes the 5% (which is $2,500 per year plus another $2,500 in company match) and to round out her Baby Step 4 she’ll be investing 10% (to get to our total of 15% of household income) or $5,000 in her Roth IRA.

Sally decides she’ll be retiring at age 60 and over her 30-year career she would have contributed $150,000 to her Roth IRA, however based on an 8% rate of return, the account value is $566,416.06. That means Sally has earned $416,416.06 that she has never and will never pay any federal taxes on!

What determines if you are eligible for a Roth IRA?

  1. You must have received taxable compensation during the year (the exception to this is spouses that do not earn an income, as long as you are married filing jointly.)

  2. You must be under certain income limitations (discuss this with your Financial Planner)

  3. You must not have already contributed the annual maximum to your Traditional IRA.

7 Other Benefits of the Roth IRA:

  1. Fewer restrictions on making withdrawals prior to retirement.

  2. Your funds can stay in a Roth IRA longer than a Traditional IRA (no required minimum distributions)

  3. You can contribute even if covered by an employer-sponsored retirement plan (401K)

  4. Investment choices are broad and diverse

  5. When you die, your beneficiaries may pay no income tax on proceeds

  6. Contributions are discretionary (up to IRS annual dollar limits)

  7. “Catch-up” contributions are allowed if you’re 50 or older

Still have questions about the Roth IRA? Be sure to reach out to a Financial Planner to talk through your specific situation.

This is a hypothetical illustration and is not intended to reflect the actual performance of any particular security. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.


December 26, 2019

Amanda Sharratt

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