Why funding a Roth IRA with disposable income first makes sense.


You have funded your 401(k) enough to receive a full company match (either traditional or Roth.)  You are paying all of your bills when they are due each month.  You have enough cash set aside for emergencies.  There is some cash left over.  Now you want to continue to save for retirement.  Continuing to fund your traditional or Roth 401(k) is a good idea.  A great idea would be to fully fund a Roth IRA before moving back to your 401(k).  You are able to take out your contributions to a Roth IRA at any time.  One day…One year…Ten years.  Any dollar you take out first comes out of your contributions so there is no worry that a portion of earnings will become taxable with possible penalties.  This is not the case for either a traditional or Roth 401(k).

If you are over the income levels to contribute directly to a Roth, no worries.  Contribute to a traditional IRA and then convert this to a Roth the next day.  Since the first contribution was nondeductible on your tax return, the conversion is tax free.  Subsequently, any withdrawals at any time, first come out of this converted amount, which will be tax free since you had basis in the full amount of the original conversion.

The only downside of doing this versus opening a taxable, non-retirement investment account, is that any growth is unable to be taken out without penalty.  This is the same downside to any retirement account.  The growth must be used for “retirement” (after you are 59 1/2 years old with a few other exceptions) to avoid penalty.

There are other nuances to Roth IRAs, such as what happens if you have a traditional IRA that has grown in value and you convert that to a Roth?   Are those dollars able to be taken out of your Roth after the conversion without penalty?  If you have this or any other questions, please do not hesitate to give us a call at (314) 993-4285.

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