7 Surprising Facts About Roth IRAs

Carlos Portocarrero — Tue, 17 Jan 2012 11:00:29 +0000

Roth IRAs are a great way to build a nest egg for your retirement. If you’re already contributing to your company’s 401(k), adding a Roth IRA can give you added tax flexibility when you start withdrawing. Since you’ve already paid the taxes on the money you contribute, you can take money out tax-free, and that will help minimize taxes from your 401(k). (See also: Optimize Your IRA and 401(k))

That’s just one of the many benefits — here are seven surprising things you may not know about the Roth IRA.

You Can Take Your Money and Run

Retirement accounts have all kinds of rules and regulations, right? Well, the Roth IRA lets you take your money out whenever you want — with no penalties. Any investment gains are subject to different rules, but the money you put in is yours whenever you want it. So if you’re worried that you might need the money, worry not — unless your investment goes down, of course.

A Roth IRA Can Fund Your First Home

If you want to take out some of those investment earnings, you can do so one time. You’re allowed to take up to $10,000 of your earnings to put towards buying a home IF you’re a first-time homebuyer.

Dividends Aren’t Taxed

Any dividends you’re paid on a stock or security you own in a Roth IRA account aren't taxed. This is a HUGE deal if you own a dividend-paying stock for many years. It can add up to thousands and thousands of dollars that you won’t ever have to pay taxes on. Can’t beat that.

It's Not for Everyone

Not everyone can contribute to a Roth IRA. These rules change annually, but for 2012 if you’re single and make more than $125,000 or married (filing jointly) and make more than $183,000, then you can’t contribute.

You Can Contribute After January 31

You have until tax day (April 15) to contribute towards to the previous year’s limit. For example, you have until April 15 to contribute towards your 2011 limit of $5,000 (or $6,000 if you’re over 50).

Death Isn’t the End

If you or your spouse dies, he/she can combine the two Roth IRAs into one without any penalty.

You Can Pass It On

The money in a Roth IRA can be passed on to an heir without any kind of penalty. It’s a really good way to pass money down to someone else.

This article is from Carlos Portocarrero of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

The Highest Yielding "Safe" Investment Now - Tax Exempt Money Market Funds

Xin Lu — Fri, 26 Sep 2008 18:10:30 +0000

Last year I wrote an article about how I used my Vanguard Tax Exempt Money Market Fund as a high yield checkings account, and this week I suddenly got quite a few hits for that article. So I wondered why that was and found that the yield for the tax exempt money market funds have shot up significantly.

The underlying investments for tax exempt money market funds are municipal short term debt also known as "munis". These are short term bonds or debt notes issued by local governments to build things like schools and libraries. The money earned from these munis are exempt from all federal taxes and also the state taxes of the locale where it is issued. Usually, the money market funds that invest in these short term debts have lower yields than their taxable counterparts since investors get a higher tax equivalent yield. However, the current situation is quite unusual and the yields have turned upside down. For example, the Vanguard California Tax-Exempt Money Market Fund's current yield is 4.66%, and that is nearly twice of the yield of the Vanguard Prime Money Market Fund. Since the California Tax-Exempt Money Market Fund's returns are not subject to state or federal taxes, 4.66% is equivalent to a taxable rate of more than 7% for someone in the 28% federal and 9.3% state tax brackets. A better deal is in the Vanguard Pennsylvania Tax-Exempt Money Market Fund, which has a yield of 5.44% and equates to a pre-tax yield of more than 8% for some Pennsylvanians. Needless to say, these yields are extremely high for tax exempt money market funds.

Why is this happening? This situation is so unusual that Vanguard actually wrote an entire article explaining it . The basic gist of the article is that since credit is tightening, municipal bond issuers have found that they need to increase their yields to attract investors. Since Vanguard simply follows the market, they are getting better yields.

Are these investments safe? Generally money market funds maintain their share values at $1.00 each, but recently we have seen a couple money market funds "break the buck" . Even so, municipal debts are generally considered to be safe investments since they are backed by local governments and their tax bases. Of course, local governments can go bankrupt so there is definitely a risk of default, but tax exempt money market funds generally have a portfolio of many different bonds from a collection of governments, so their risk is lower.

Finally, money market yields change everyday so no one knows how long these high yields will last. However, since money market funds are as liquid as cash, you can always move your money when the yields go down. For now, I really cannot find another "safe" investment vehicle that pays as high as these funds.

Disclosure: I own the Vanguard California Tax-Exempt Money Market Fund (VCTXX) and the Vanguard Prime Money Market Fund (VMMXX)

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

tax free