Good things come to those who wait—for a tax break. Although you fund a Roth individual retirement arrangement (IRA) with after-tax dollars, the money you distribute is completely tax-free as long as it meets certain requirements. And that means a really good thing—you may never pay a cent of tax on your earnings.
The Roth IRA is one of the few savings vehicles that gives you this advantage, and it’s a big one. Suppose you put $5,500 a year (the maximum contribution limit for 2014 and 2015) into a Roth IRA for 25 years at a 1% return. You would end up with $142,061—$17,063 of which would be tax-free earnings! It’s the magic of tax-deferred compounding.
You’ve seen how time plays a key role in maximizing Roth IRA potential. That’s exactly what makes the Roth so appealing if you’re just starting out with a savings plan, according to Dennis Zuehlke, compliance manager for Ascensus in Middleton, Wisconsin.
“The younger you are, the longer your money can grow before you take it out,” Zuehlke says.
Zuehlke adds that young savers are likely candidates for the Saver’s Tax Credit.
This nonrefundable tax credit can total up to 50% of the first $2,000 you put into a Roth IRA each year. To qualify, you must be at least age 18 and you cannot be a full-time student or a dependent on someone else’s tax return. And, there are income limits. For example, a single person with 2015 adjusted gross income up to $18,250 would receive a tax credit equal to 50% of the first $2,000 of IRA contributions, and a reduced credit is available up to $30,500.
“Combine the Saver’s Tax Credit with all the other tax savings of a Roth IRA and it can really make a difference,” Zuehlke says.