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How a Roth IRA Could Save You $185,180 in Taxes

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Roth IRA
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Tax season is almost over, and there are only a few things left that you can do to affect what you owe for 2012. But looking forward to the 2013 tax year and beyond, adding a Roth IRA to your arsenal of retirement investing tools could save you a ton in taxes in the long run.

The Best Way to Pay Zero Tax

Ever since they first became available to retirement savers in 1998, Roth IRAs have offered a unique opportunity. In a departure from past methods of saving for retirement that involved deferring taxable income until future years, Roth IRAs changed the timing of the tax break they offered. Rather than giving you an upfront tax deduction that can lead to tax savings right now, Roths give you all their benefits on the back end: Assets within an account grow free of tax, and the withdrawals you take at retirement are eligible for tax-free treatment as well.

With tax rates on the increase, the value of being able to shelter income from tax has gone up quite a bit this year. Moreover, with current proposals aimed at raising taxes even further in the years to come, getting money into a Roth IRA now -- while that opportunity is still available -- could be even more valuable in the future.

Just How Much Is a Roth Worth?

Skeptics might argue that the maximum contributions of $5,000 for the 2012 tax year and $5,500 for 2013 -- plus an extra $1,000 if you're 50 or older -- don't give you enough in tax savings to be worth the effort. But depending on how successful an investor you are, getting the tax-free growth that Roth IRAs provide can be worth a lot more than you'd expect.

As an example, turn back the clock to 1998, the first year Roth IRA contributions were available. Back then, you were allowed to contribute only $2,000 per year to a Roth IRA. Since that time, an investment in an S&P 500-tracking index fund has produced returns of about 5 percent per year, which would have taken your initial $2,000 investment up to almost $4,250. With maximum tax rates on capital gains and dividends of 20 percent, a Roth could have saved you as much as $450 in taxes.

That's nice, but it's far from extraordinary. Yet consider this: if you were fortunate enough to choose some of the top-performing stocks in the market for your Roth, the impact would have been much more substantial. The numbers will shock you:
Stock Total Return Since 1998 Potential Tax Savings on $2,000 Initial Investment
Gilead Sciences (GILD) 3,941% $15,364
Amazon.com (AMZN) 5,101% $20,004
Apple (AAPL) 13,105% $52,020
Celgene (CELG) 16,484% $65,536
Monster Beverage (MNST) 46,395% $185,180
Source: S&P Capital IQ. Assumes current maximum long-term capital gains rate of 20%.

Clearly, these results are extraordinary. And, sure, maybe you're not a star stock picker. But the examples above clearly illustrate the full power of the Roth IRA in action, as the tax-free retirement vehicle was custom-made for maximum-growth stocks.

Finding those successful stocks is certainly challenging, but when you do, having them within a Roth IRA unlocks their full profit-producing potential.

Ride Your Roth to Riches

Most people are eligible to contribute to a Roth IRA, with income limits putting restrictions only on certain high-income taxpayers. Moreover, even if you can't contribute directly to a Roth, you may be able to convert an existing IRA or 401(k) into a Roth account.

Either way, using a Roth IRA makes sense for many taxpayers, especially those for whom current tax deductions from traditional IRAs are either unavailable or of minimal value. The better the investments you find, the more they'll pay off for you in tax savings within a Roth.

Motley Fool contributor Dan Caplinger owns shares of Apple. The Motley Fool recommends Amazon.com, Apple, Gilead Sciences, and Monster Beverage. The Motley Fool owns shares of Amazon.com, Apple, and Monster Beverage.


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susanshelleyforassembly

President Obama's budget proposal calls for limiting the amount of retirement savings that can grow tax-free to an amount that's "needed" for a "reasonable" retirement. So if you put your money in a Roth and it grows above that level (whatever that level turns out to be when you retire), you'll owe taxes on it, Roth or no Roth. Call your congressman and senators and tell them you don't appreciate the bait-and-switch, and you're watching to see if they vote for that. -- www.SusanShelley.com

April 14 2013 at 8:28 PM Report abuse rate up rate down Reply
yurday6

Wow ZERO percent interest = Zero percent taxes.

April 14 2013 at 1:23 PM Report abuse +1 rate up rate down Reply
olirockgirl

I converted a 22 thousand dollars IRA into a Roth many years ago paid 10 thousand dollars in taxes over 4 years and that Roth is now worth 11,800 dollars. Technically I lost the 10 thousand in taxes and 11 thousand of my money. So much for the Roth!

April 14 2013 at 1:09 PM Report abuse +1 rate up rate down Reply
grstewartcpa

The only way to save money is that your Roth IRA has to make money. And with the economy the way it is no one will. So saving taxes is a mute point.

April 13 2013 at 1:24 PM Report abuse -2 rate up rate down Reply
cslinz62

I gave up finding a job and I don't invest since interest rates are down to near nothing. I gave up on the american dream a couple years ago. I've been divorced 19yrs. and I gave up finding a man to get remarried.

April 12 2013 at 11:13 PM Report abuse -1 rate up rate down Reply
xbuanu

Put it in a Roth IRA CD that pays nothing. Guess how much tax you save on nothing?

April 12 2013 at 10:53 PM Report abuse -3 rate up rate down Reply
1 reply to xbuanu's comment
labourboss

My wife put $5000 in a Roth as soon a President Obama was elected. She invested it in GE which was selling at around $6 a share. Since then she sold that and bought something else. Bottom line is that particular portfolio of her's is worth over $20000 now.

April 13 2013 at 12:19 AM Report abuse +4 rate up rate down Reply
mightymoving

dont trust these roth ira's they are a complete scamm..nothing the goverment does is trust worth..
nothing zero swallow that senators

April 12 2013 at 7:53 PM Report abuse -4 rate up rate down Reply
1 reply to mightymoving's comment
labourboss

The government has nothing to do with the Roth itself. You can go and invest the money in any brokerage house.

April 13 2013 at 12:15 AM Report abuse +4 rate up rate down Reply
packard54

I have been contributing since the beginning and believe me, the payoff has been great. Bill Roth was always looking for a way to help the average worker and he hit the jackpot with this one. He was a GOOD Republican and many have benefitted from his efforts. If you aren't investing in Roths, DO SO! Drive past the car dealer and buy a good used car then take the difference in payments and invest it in a Roth IRA. You will never regret ti. My "Mercedes" is in my portfolio. I drive a 12 year old minivan and will until the wheels fall off.

April 12 2013 at 2:28 PM Report abuse +5 rate up rate down Reply
paddleman1928

if the gov't doesn't confiscate it.

April 12 2013 at 8:05 AM Report abuse -2 rate up rate down Reply
2 replies to paddleman1928's comment
jrose1a

It will be interesting if they do. I hope there is a weeks notice so I can be on I-66 with a truck load of pitch forks to sell.

April 12 2013 at 11:13 PM Report abuse +2 rate up rate down Reply
mmauneyjr

Have you seen the retirement account limits in the Obama budget proposal?

April 13 2013 at 5:20 PM Report abuse rate up rate down Reply
1 reply to mmauneyjr's comment
Jdhdnumber7

There are already account limits on Roth, IRA and 401Ks plus depending on how much you make limits your ability to participate.

April 13 2013 at 7:01 PM Report abuse +1 rate up rate down