While most retirement savings plans are based on up-front tax breaks, with the understanding that your withdrawals will be fully-taxable in retirement, the Roth IRA offers the opposite approach.
You get no initial tax break, but all future earnings and withdrawals are tax-free as long as your account has been open at least five years and you are at least age 59½. Plus, since you contribute after-tax dollars, you are able to withdraw your contributions (but not your earnings) at any time, tax-free and penalty-free.
Roth IRAs are a great option for anyone interested in tax-free retirement income, and are particularly good for young workers who could benefit from decades of tax-free growth. Roth IRAs are also good for anyone who expects to be in a higher tax bracket in retirement.
There are, however, eligibility limits. For 2014, single taxpayers can contribute up to $5,500 to a Roth IRA, or up to $6,500 if you are 50 or older, only if your income is $114,000 or less. You can make a partial contribution to a Roth IRA if your income is between $114,000 and $129,000. Once your income tops $129,000, you are not eligible to contribute to a Roth IRA.
For married couples, $5,500 or $6,500 contributions can be made for each spouse, if income is under $181,000; the right to make contributions is gradually phased out as income rises between $181,000 and $191,000.
If the idea of tax-free income in retirement appeals to you, and your income is too high to qualify, there's a backdoor entrance to the Roth IRA. You can convert a traditional IRA to a Roth IRA, regardless of your income.
If these nondeductible contributions represent your only IRA money, then you will just owe taxes on the earnings when you convert to a Roth IRA.
However, if you have other IRA assets funded with deductible contributions, only a portion of the amount you convert will escape taxes, since all conversions must be done on a pro rata basis based on the total balance in all of your IRAs. A more generous rule exists for after-tax contributions to a 401(k). You can roll over all after-tax contributions directly to a Roth IRA tax-free.
Employers are allowed (but not required) to offer a Roth option for their 401(k) plans. Like the Roth IRA, contributions to a Roth 401(k) are made with after-tax dollars and future withdrawals will be tax-free as long as you adhere to the rules.
If your employer offers a Roth option, consider seriously whether you would be better off foregoing the immediate gratification of a tax break today for the delayed gratification of tax-free income in retirement. You can choose to split your contributions between a traditional and a Roth 401(k) as long as your combined contributions do not exceed the annual limits.
Using TurboTax Deluxe will help you take advantage of retirement-related income tax deductions.