||Ask the Dollar Diva
How to become a millionaire with a Roth IRA
Dear Dollar Diva,
How good is the Roth IRA, and how easy
is it to acquire?
How good is the Roth IRA? It's not as good as winning the
lottery or marrying a millionaire, but it's up there. The younger
you are, the sweeter it is because you have more years to accumulate
tax-free earnings. An illustration using a 30 year-old-taxpayer
with $20,000 in his Roth IRA follows.
The Roth IRA is also very easy to acquire.
Although you don't get a tax deduction for your Roth IRA
contribution, all future qualified
distributions will come to you tax-free; that includes your
original contributions plus the income and appreciation that the
investment earns over its lifetime.
Let's pretend 25-year-old John invests $3,000 in a
Roth IRA every year for five years and the investment earns 10 percent
a year. At the end of five years, his total account would be worth
about $20,000 -- $15,000 in contributions and $5,000 in earnings
Let's pretend he never puts another dime in this account;
the $20,000 just sits there generating income and appreciation at
10 percent a year. If he allows the IRA to grow until he's 72, John
will be rewarded with $1,280,000 in tax-free dollars. The years
between his twilight and sunset can be spent traveling around the
world instead of clipping coupons. If he's already seen the world,
he can pay for his grandkids' college educations or let the account
keep growing, so his heirs will have something nice by which to
The Rule of 72
You can quickly calculate how big your nest egg will grow
by using an approximation called The Rule of 72: Divide 72 by an
interest rate and voila! That's how many years it takes to double
your money. So if John's $20,000 earns 10 percent, 72 divided by
10 is about seven.
Here's how the account would grow from $20,000 to
$1,280,000 using the Rule of 72:
A dollar will be worth a lot less in 2044 than it
is today, you say. The Diva responds: It's going to take a lot more
than 42 years to reduce a million and a quarter to chump change.
For more on the upside of the Roth IRA, read the Diva's
conversions look good."
How much can you invest in a Roth IRA?
Most working folks can contribute up to $3,000 to a Roth IRA
in 2002; if you're older than 50, it jumps to $3,500. Here are some
of the rules and limits:
are no age limits; if you have taxable compensation (wages, bonuses,
tips, self-employment income), you can contribute to a Roth IRA.
No paycheck, no Roth. You
have to have taxable compensation of at least $3,000 to contribute
$3,000 to an IRA; at least $3,500 to contribute $3,500.
Income limits. The
ability to make Roth IRA contributions phases out for single taxpayers
when their modified AGI is between $95,000 and $110,000; for married
taxpayers filing jointly, the phase-out range is $150,000 and
Time frame. You
have until April 15, 2002 to open a Roth IRA account and make
a contribution for 2001. The maximum contribution for 2001 is
$2,000. Contributions for 2002 can be made anytime from Jan. 1,
2002 to April 15, 2003. But remember, sooner is better than later
when it comes to accumulating tax-free earnings.
Low-income taxpayers invited to the
feast. This is new for 2002. The IRS
is giving tax credits to low-income workers (not students) for
making contributions to retirement plans, such as Roth IRAs; Uncle
Sam wants everyone to save for retirement. For more on this go
Changes for 2002" on the IRS Web site.
For more information on traditional and Roth IRAs,
Publication 590, Individual Retirement Arrangements (IRAs).
The downside of the Roth IRA
OK, the Roth IRA is not perfect; but what is?
Here are some of the things you'll want to think about before you
become a Roth IRA groupie:
- In most states, your traditional IRA and other
tax-deferred retirement plans are creditor protected; no one can
touch them but you. Not so with the Roth. In most states it gets
put on the block if there's a judgment against you. If you think
you might get sued, file for bankruptcy or dump your spouse, the
Roth IRA may not be a good choice for you.
- There's always some uncertainty when you're dealing
with Uncle Sam. Will he change his mind about the tax-free status
of Roth IRA distributions in the future? Some folks pay tax on
85 percent of their Social Security payments; will that be the
fate of the Roth IRA 30 years from now? Your guess is as good
- If you want to convert a traditional IRA to a Roth,
beware of the minefields: You can be pushed into a higher tax
bracket; if you're collecting Social Security, more of it
will probably be taxed; and the addition to adjusted gross income
may cause you to lose benefits such as education and child tax
credits or deductions for student loans.
How easy is it to acquire?
A Roth IRA isn't an investment, per se. It's more like a label
put on an investment to identify it as a retirement account. The
actual investment can be in stocks, bonds, mutual funds, money market
accounts, certificates of deposit or gold bullion. It cannot be
in vintage wines, Mapplethorpe photos, rubies, stamps or other collectibles.
First, decide what you want to invest in. Then, find
a financial institution to sell it to you. Fidelity,
Rowe Price and Vanguard
will sell you no-load mutual funds with reasonable expense ratios;
search the Web for more.
If your time horizon is long, investing in stocks
or stock mutual funds is the way to go. Do your homework first:
Start by reading the Diva's "Investment's
magic formula: Allocation plus annual rebalancing." It
will link you to other stories that will help you get started.
If you know nothing about investing but want to have
your money in the market while you learn more about it, the Diva's
fund alphabet soup? That's a load" will introduce you to
the S&P 500 index fund; that boring, no-brainer fund that makes
investing simple and delivers market returns year after year. Like
the market, some years are good, others are bad, but over the long
haul you can expect a better return than you'd get with most other
If your time horizon is short and you want to invest
in certificates of deposit, shop around for the best deal. To compare
what's out there, Bankrate.com's CD
rate search engine gives up-to-the-minute rates. Once you find
the one you like, call or visit the bank; a representative will
be more than happy to help you fill out the Roth IRA application.
The lower tax rates go, the better the Roth IRA looks.
Everyone knows what goes down must come up, so investing in the
Roth with after-tax dollars when the tax rates are low and taking
tax-free distributions in the future when rates may be higher sounds
like a pretty good strategy to the Diva.
-- Posted: Jan. 17, 2002