Week 14 Day 3: The Roth IRA: Tax-Free Forever

You contribute after-tax money to a Roth IRA. It grows. And grows. And grows. When you withdraw in retirement, you pay zero tax. On any of it. If you put in $7,000 and it grows to $70,000 over 30 years, the full $70,000 is yours. Uncle Sam gets nothing.

The Roth IRA has several unique advantages beyond tax-free growth: (1) No Required Minimum Distributions (RMDs). Unlike a 401(k) or Traditional IRA, a Roth IRA never forces you to withdraw. You can let it grow your entire life and pass it to heirs. (2) Contribution flexibility. You can withdraw your contributions (not gains) at any time, penalty-free, for any reason. This makes it a stealth emergency fund. (3) Tax diversification in retirement. Having both pre-tax (401k) and post-tax (Roth) accounts gives you flexibility to manage your tax bracket in retirement by choosing which account to draw from. Income limits apply: in 2024, single filers earning above $161,000 and married filing jointly above $240,000 cannot contribute directly. But the 'backdoor Roth' (contribute to a Traditional IRA, then convert) is available to everyone regardless of income.

The Roth IRA was created by the Taxpayer Relief Act of 1997, named for Senator William Roth of Delaware. The economic argument for the Roth is based on the expectation that tax rates will rise over time -- a reasonable assumption given projected Social Security and Medicare shortfalls and the national debt trajectory. The net present value comparison between Traditional and Roth contributions depends on the ratio of current to future marginal tax rates. If t_future > t_current, the Roth wins. If t_future < t_current, Traditional wins. For young workers in low tax brackets who expect income growth, the Roth is almost always optimal. The backdoor Roth IRA strategy (contribute to non-deductible Traditional IRA, then immediately convert to Roth) was implicitly blessed by the IRS and explicitly legal after the 2010 removal of income limits on Roth conversions. The 'mega backdoor Roth' -- contributing after-tax dollars to a 401(k) beyond the $23,000 limit and converting to Roth -- allows up to $46,000/year additional Roth contributions if your plan permits it.