The smartest move a younger person can make is to invest in a Roth IRA. A person who starts saving $5,000 per year in a Roth IRA at age 20 will have over $1.5 million at age 60 if it grows at eight percent. Provided the person has followed the rules, he won’t owe the IRS a nickel on any of the money.
Many taxpayers, young and old, find it difficult to give up the immediate tax savings they’d receive if they chose to make a traditional IRA contribution that’s deductible. In the example above, if the same person contributed to a traditional IRA, the entire $1.5 million would be taxable. He’d have saved about $50,000 in taxes along the way but would owe over $200,000 in taxes when he tried to spend any of the money.
As the example demonstrates, there’s no doubt the Roth IRA is a better choice for a younger person. In addition, a Roth contribution is a great way to gift money to your children or grandchildren as long as they have earned income. In addition to the long-term, tax-free growth your gift would provide them, they may also qualify for the retirement savings tax credit.
Basically, the lower the income, the bigger the credit. Contributions to traditional and Roth IRAs as well as to 401(k) plans count toward computing the credit. In the case of the 401(k), only the employee contributions count, not any matching amounts the company contributed. The retirement savings credit is only available if the person files his or her own return and isn’t claimed as a dependent on another person’s tax return.
