If you’re a “Gen-Xer,” born between 1965 and 1980, you’ve still got many years to go until you retire. At this stage of your life, what can you do to help build resources for the retirement lifestyle you’ve envisioned?
Besides having time on your side, you’ve got another key advantage in saving for retirement - specifically, you probably haven’t reached your peak earning years. This helps you in at least two ways. First, of course, it means you should be able to increase your retirement savings in the future. And second, it might mean you’re still eligible to contribute to one of the most effective retirement accounts available - the Roth IRA.
When you invest in a Roth IRA, your earnings are distributed tax free, provided you’ve had your account at least five years and you don’t start taking withdrawals until you’re at least 59½. For the 2013 tax year, you can put in up to $5,500 to a Roth IRA; when you reach 50, you’ll also be able to make “catch-up” contributions. (Currently, the catch-up limit is $1,000.)
However, the ability to make Roth IRA contributions is limited by income. For 2013, you can make the full contribution to a Roth IRA if you are single and your modified adjusted gross income (MAGI) is less than $112,000. Above this amount, your contribution limit will be gradually reduced, and if your MAGI reaches $127,000, you won’t be able to contribute at all. If you’re married filing jointly, the lower limit is $178,000 and the cutoff amount is $188,000.
Of course, if you have to consider these income limits, you’re making a reasonably good living, and you may well be on a career path that will take you to even greater earnings - which is why you should think about putting in as much as possible to a Roth IRA while you’re eligible.
If your earnings are already over the limit for the Roth IRA, you can still contribute to a traditional IRA. Your contributions can grow tax deferred, which means your money can accumulate faster than it would on an account on which you paid taxes every single year. Taxes are due upon withdrawal, and withdrawals prior to age 59½ may be subject to a 10 percent IRS penalty.
But what if your income level is such that you could contribute to either a Roth IRA or a traditional IRA? Which one should you choose?
There’s no “right” answer for everyone. On the one hand, the Roth’s tax-free distributions may be more attractive to you than the tax-deferred growth potential of a traditional IRA if you expect your tax rate to be higher in the future. However, depending on your income level and whether you have access to a 401(k) or other retirement plan at work, your traditional IRA contributions may be fully or partially tax-deductible. But these types of calculations are not easy, so before making the traditional-or-Roth choice, you’ll need to consult with your tax advisor.
In any case, now is the time to capitalize on your Gen-X status and use the years ahead to invest consistently in an IRA and other tax-advantaged retirement accounts. As an investor, time is your greatest ally - so take advantage of it.
Brian Humphrey is a financial consultant and investment advisor.