There's always a conflict when you save money. On the one hand, if you build up your savings, you can have it available at any time you need it. On the other, contributing to a Roth IRA will give you tax-free growth for retirement and you might be able to get a tax credit if your income is below a specified amount. Making the best decision all depends on your situation.
You need to have some easily accessible funds for emergencies. That's where a savings account is at its best. While some planners suggest that you keep at least 3 to 6 months of income in a high-yield savings, others believe the amount should be closer to 10 percent your annual income if you work a stable job for someone else, or increase that amount to 20 percent if you're self-employed. If your job is on shaky ground, go even higher.
The younger you are, the more benefit you'll reap from a Roth IRA. In a Roth, you don't pay taxes on the growth. The more time you have the money grow, the bigger the growth and the more you'll save in taxes. If you put $1,000 in a Roth when you are 50 and received a 6.5 percent return, you'd have $ 915.43 grow free of taxes by the time you hit 60. However, if you were 25 when you put it in, the tax-free growth would be $8,725.92, which is a huge difference.
While it's tempting to put funds in because of the tax savings, if you don't have emergency funds or think you might need the money, you'll pay dearly. If you remove funds from the Roth before the age of 59 1/2, you'll pay not only the taxes on the growth, but also a 10 percent penalty. As of 2010, your income must be below $105,000 if you're single, or $167,000 if you're married filing jointly, to qualify for a Roth.
The good news is that you don't have to have it an all or nothing proposition. Set aside a small amount each month for your Roth IRA with a larger amount toward your savings until you build the amount of money necessary for emergency use. Simply tucking away $10 a week accumulates to $520 by the end of the year and is enough to start a Roth IRA without dramatically affecting the amount you save. As of 2010, if your income is less than $27,750 and you're single or married filing separately, or if your income is $41,625 and you're married filing jointly, you'll get a tax credit for the Roth deposit.
If you put money into a Roth and receive a tax credit, but have to remove it within a year or two, you'll find the 10 to 50 percent tax credit gave you more benefit than the 10 percent penalty on growth costs. It's a win-win situation.
Before you invest in any product for your Roth, check for fees and minimums. Steer clear of the product if it has an annual fee. Some annual fees are large enough to wipe out any growth and may even dip into your principal.
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