Roth IRA

A client expects to be in a higher tax bracket in retirement. Which account is often preferable?

1. A.A Roth IRACorrect - pay tax now at lower rates.
2. B.A fully taxable brokerage accountA taxable account offers no shelter at either end, so a client expecting higher future rates gets no relief from it. Dividends and realized gains are taxed as they occur, and again on any appreciation when positions are sold.
3. C.A traditional IRA onlyThe traditional IRA is the better answer to the opposite fact pattern, where the client is in a high bracket now and expects a lower one later, and its up-front deduction is a real benefit. Here the client expects higher rates in retirement, which favors paying tax now at today's lower rate and taking qualified withdrawals tax-free.
4. D.A checking accountA checking account is not a retirement vehicle and carries no tax treatment to compare. Any interest is taxed currently, which leaves the client fully exposed to whatever bracket applies.

Why: A Roth IRA (tax-free qualified withdrawals) benefits those who expect higher future tax rates.

A Roth IRA is best defined as a retirement account funded with:

1. A.Pre-tax dollars, with withdrawals taxed as ordinary incomeDescribes a traditional IRA, the mirror image of a Roth.
2. B.After-tax dollars, with earnings taxed as capital gains on withdrawalQualified Roth earnings are not taxed at all, and retirement accounts never produce capital gains treatment.
3. C.Employer contributions only, with no employee participationRoth IRAs are funded by the individual, not by an employer.
4. D.After-tax dollars, with qualified withdrawals of contributions and earnings free of federal income taxCorrect. No deduction going in, no tax on qualified distributions coming out.

Why: A Roth IRA is funded with after-tax dollars, so contributions are never deductible, but qualified distributions of both contributions and earnings come out entirely free of federal income tax.

A 30-year-old in a low tax bracket expects to earn far more later in her career. She wants her retirement withdrawals to be free of federal income tax. Which account best matches her goal?

1. A.A Roth IRACorrect. She gives up a low-value deduction now in exchange for tax-free withdrawals later.
2. B.A taxable brokerage accountDividends, interest, and gains are taxed as they occur and again on sale.
3. C.A traditional 401(k) with the maximum employer matchA match is valuable, but traditional deferrals are still taxed on withdrawal.
4. D.A traditional IRATraditional withdrawals are fully taxable, which is the opposite of her stated goal.

Why: A Roth IRA gives up the current deduction, which is worth little in a low bracket, in exchange for tax-free qualified withdrawals later when her bracket is expected to be higher.

Amara Sundaram, 34, is in a low tax bracket now and expects a much higher income in retirement; she asks her adviser how a Roth IRA is treated going in and coming out. A Roth IRA offers:

1. A.An upfront deduction and taxed withdrawalsThis describes the traditional deductible IRA, where the tax break comes first and distributions are taxed. The Roth reverses the order: contributions are made with after-tax dollars, and qualified withdrawals come out tax-free.
2. B.Employer matching requiredEmployer matching is a feature of workplace plans such as a 401(k). A Roth IRA is an individual account opened directly with a custodian, with no employer involvement at all.
3. C.Tax-free qualified withdrawals and no lifetime RMDsCorrect - Roth's key advantages.
4. D.Mandatory withdrawals at 59 and a halfAge 59 1/2 is when qualified withdrawals may begin without penalty, not when any withdrawal is required. A Roth IRA has no required minimum distributions during the owner's lifetime, which is one of its planning advantages.

Why: A Roth IRA provides tax-free qualified withdrawals and has no required minimum distributions during the owner's lifetime.