OK so my wife and I have been talking about our money situation, not an uncommon topic, and we're trying to think about long term goals. One of them is to take advantage of IRAs. Now we've used a standard IRA in the past for tax purposes, but now that we both have jobs with a pension plan the tax break is broke. So for years we've had our traditional IRA just sitting there making money on its own with no new contributions. It seemed to both of us that IRAs had to exist for some reason and we were missing out by not using one. So here is what I've learned in studying all of this.
The first thing to address is why the standard IRA doesn't really work for us. Since we are both on a pension plan with our jobs, we cannot deduct the money we put into a standard IRA. This means basically there has been no incentive for us to put any money into the IRA because we get no tax break from it.
Now I've heard of Roth IRAs for a long time but never really understood what they were or how we might be able to take advantage of their tax breaks. So this week I sat down and did some reading. It is very simple actually. The money that you put into a Roth IRA gives you no deduction from your taxes, but the beauty is that any money it earns is tax free. For example let's say I bought 100 shares of RBC at $32 per share in 1999 then sold it today for $89 per share. That would be a profit of $5,700. Now if it were in a standard brokerage account I would have to pay capital gains tax on that money, but in a Roth IRA I would not.
So what are the catches. Like a standard IRA there is an annual contribution limit. You can pay penalties if you remove earnings from your Roth IRA prior to turning 59 1/2 or you've had the account for less than 5 years.
But there are other upsides that I didn't know about. You can remove your contributions to a Roth IRA tax and penalty free at any time. After 5 years you can also withdraw earnings tax and penalty free for home purchase, college, or major medical expenses.
A pretty sweet deal it seems to me and something my wife and I agreed we should be taking advantage of. Now the trick with this stuff is how do you get started since it always takes a chunk of cash to get started. Well this isn't really true it turns out and here's why.
We could for instance start a Roth IRA with out credit union for a mere $25 startup. There is no charge for startup and no fee. This account is basically a variable rate money market account.
But what if we want more control over the money, something similar to a brokerage account. Well I looked at a few companies (Schwab, Fidelity, ETrade, Ameritrade, and Vanguard) and here is the one I found. At ETrade you can start up a Roth IRA with no minimum startup investment and no fees as long as you choose to get all statements electronically. No minimum completely blew my mind.
OK and one other thing. A cool thing about a Roth IRA is that you and your spouse can share it jointly. You cannot do this with a standard IRA. That means that you can put up to $8,000 a year into this account and really build up your earning potential much quicker.
