Why now is the right time to start a Roth IRA
I’ve said it before and I’ll say it again. Roth IRAs are my favorite account type. Why? Well, lots of reasons, but here are a few. Most can add to them (though you might have to utilize some loop holes to get there), the tax benefits can be massive (though the longer you have, the better), they have flexibility other retirement accounts don’t (for example the five-year early distribution rule), and the estate planning and inheritance process is much more favorable than pre tax accounts.
So, we understand that I like Roth IRAs. Now, why do I think now is the right time to start one? Here are three reasons I think now is the right time to start your Roth IRA or make sure it’s funded for this year if you already have an existing Roth IRA. First, most of the markets are down. Second, taxes are at historic lows. Last, the sooner the better.
Most Markets are Down
As of the writing of this blog, most major stock indices are down for the year and off their peaks. Some are up of course, but overall, there are a lot of good investing opportunities. Now, let’s be clear – I’m not advising you to try and time the markets. I actively discourage market timing, but things overall are down and markets historically have fluctuated up and down, so buying when it’s down is an advantage.
In an account like a Roth, maximizing gains (as gains are never taxed as long as the Roth is funded and withdrawn according to the rules) it’s even more favorable. In a non-retirement account, when you have gains, you have to pay taxes in the tax year of the gains. Similarly, when you have losses, you can use the to offset gains or income (depending on the type of gain and loss – I’m won’t go into the details here of income versus capital gains).
No one likes to have losses in their investments, but in some accounts, you can use losses to your advantage. In a retirement account, a Roth IRA specifically, there is no benefit to having a loss. Take advantage while you can and take advantage of everything you can.
Remember, you probably won’t get in at the very bottom (if you’re getting in now, you probably missed it by a few months already), but getting in when it’s not at a record high is pretty good.
Taxes are at a Relatively Low Level Historically
Let’s not get into an argument here about how you don’t like paying taxes or your taxes are misspent or are too high. Historically, income tax tables today are toward the lower end of where they’ve been in the past. We just had a federal tax cut in 2017 and major tax cuts don’t come around that often.
No one can predict the future, but I personally believe with the national debt increasing, social security and other government programs being underfunded, and federal spending on the rise, taxes will have to increase sometime to make up for these things. At some point, a politician will be an adult with a calculator and will realize things need to change to reconcile the financial magic that’s going on at the federal level. I’m not sure when, I’m not sure who, but I believe sometime it will happen. It’s not certain of course, there are other options. We could reduce military or other spending to create a surplus and fix these systems or the systems could be cut entirely, but I think increasing taxes is more likely than the alternatives.
The point is, if you believe that it is likely taxes will increase in the future, it probably makes sense to direct some of your savings to tax free savings (like a Roth IRA).
The Sooner the Better
What does that even mean? It means that the more time you have in a Roth IRA, the better. There are a few key items that make being invested in a Roth better the longer you’re in it.
First, the more growth you have, the greater the tax benefit. If you’re invested for growth in your Roth, this applies to you. Back to my earlier point, qualified Roth withdrawals are not taxed. To be clear, by qualified I mean Roth withdrawals that are taken according to IRS rules, id est, after the account’s been open for five years and you’re age 59.5 or greater. The more growth in your Roth, the more money you’ll never have to pay taxes on.
Second, if you’re just starting your Roth, there’s a weird rule with Roth IRAs that you can’t take your first withdrawal until the account has been open for five years. This is a once time rule you have to satisfy, so if you previously had a Roth, but no longer do, it’s only required once. Two benefits to this, one is you have to satisfy it prior to any withdrawals, regardless of age. The other is Roth IRAs have the fantastic benefit that if you have opened the account for over five years, you can withdraw your basis (or the amount you invested into it) with no tax and no penalty. So, if you have a Roth IRA over five years old and no other type of savings, the basis in it can serve as an emergency fund.
Early Roth IRA withdrawals are definitely something I don’t advocate for, but it’s a super helpful rule to know and utilize in emergencies. It’s something that can be helpful and is good to have, it could be used in a plan, but can be risky and complicates things, so be careful if you use this early strategy as part of a plan.
That’s it. Three reasons I think now is the time for you to start or fund your Roth IRA are most major indices are off their peaks for the year still, taxes are at historic lows and have only one way to go (up, to be specific), and the sooner you start, the more benefits you’ll be able to derive.
If you’d like to discuss a Roth IRA and your financial situation or create a financial plan, Telos Financial welcomes the opportunity to talk with you. Contact us today to schedule a no cost or obligation introductory meeting. Telos is a financial planning firm serving Michigan’s high income and high net worth millennials, recent college graduates, and small business owners.
Telos Financial is a fee based, holistic financial planning firm located in Plymouth, Michigan serving young professionals and their families. Dennis LaVoy is a Certified Financial Planner® Designee and a Chartered Life Underwriter®. Dennis is proud to be a firm based in Michigan focused on serving high net worth and high-income young professionals, millennials, and those preparing for retirement. He founded Telos Financial and to provide fiduciary financial services to families across Michigan including Plymouth, Canton, Ann Arbor, Detroit, and as well as all over the great United States of America.
Thanks for reading the latest edition of Planning for your Purpose, Telos Financial’s blog, where I discuss different topics related to financial planning. CERTIFIED FINANCIAL PLANNER™ professional Dennis LaVoy is Plymouth, Michigan’s holistic financial advisor serving clients throughout the mitten as well as across the country.
The primary purpose of the blog is to introduce financial planning concepts and questions I receive from clients that I believe are important. I want to start discussions that will educate, benefit, and improve your financial life, ultimately, to help you focus on your telos!