By: Frank Armstrong
As seen on Forbes
The two biggest concerns for many of our clients are retirement and college funding. Here’s one approach that can ease the burden for both: Contribute to a Roth IRA. The Roth is a powerful tool that can do double duty as a retirement and college funding account. Here’s an example:
Suppose you started the Roth when you child was born and contributed $5500 each year for 18 years. Your total contributions would have been $99,000. But, the account value if we presume a net 8% return would have grown to $205,976.34.
You can withdraw your $99,000 tax free and free of any nasty penalty tax. You have already paid the tax on that. The balance, of $106,976.34 can continue to accumulate tax free until you retire or reach retirement.
If, for example, you started at age 25, you would be 43 when you withdrew the funds for your child’s college expenses. And, of course, you have 17 years until age 60 for the funds to grow. Assuming no further contributions and again assuming a net 8% return your account is now worth $395,814.39. If you wait to age 65 it grows to $581,581.20. Finally, using the same assumptions, at age 70 it has reached $854,533.58. For most of us these are not trivial amounts. If every family regularly contributed to an IRA America wouldn’t have the retirement crisis we are facing.
I certainly wouldn’t want to discourage you from continuing to contribute after year 18, and if you do the numbers will only grow for your future retirement.
It’s all totally income tax free, and not subject to those icky Minimum Required Distribution (MRD) rules. If you are just not able to spend it, any amounts you accumulate can be passed on to your spouse, and if he/she isn’t able to spend it, they can pass it on to your children or grandchildren totally income tax free. But, it will be subject to rules that spread it out over their projected lifetimes.
If your spouse contributes to a similar Roth IRA, or if you contribute for him/her the amounts double.
It goes without saying that accumulations are dependent on rate of return, but 8% is at the bottom range of reasonable expectations for long term return in an equity portfolio. As always, keep costs low and control risk through wide diversification.
Whatever the actual rate of return in your account, you can always withdraw your contributions without adjusting for market fluctuations when needed for college expenses.
Contributions are limited to incomes above $129,000 for single filers and $191,000 for joint filers for the 2014 tax year. But, not to worry, if you exceed those limits you can always do a non-deductible IRA and then convert right away. That’s the so called “Back Door IRA’. It gets you to the same place.
Additionally, there are no income limits for conversion of existing Regular IRAs or rollovers from previous employer 401(k) plans but you will have to pay the taxes on the amount realized.
Finally, tax free withdrawals of your contributions from the Roth IRA are not limited to education. You could, for instance, purchase a boat or make a down payment on a home with the $99,000 instead.
Any accumulation above your contributions is subject to income tax and possible penalty tax if you are under 59 ½ and if the funds have been invested for less than 5 years.
As my mother used to say, never waste a chance for tax free accumulation. So right, Mom!