Chris Farrell: Paid-off mortgage frees cash for Roth IRA

Q My wife and I paid off our mortgage and have both opened Roth IRA accounts with monthly contributions of $500. Our mortgage payment was $1,100.00. Also we learned that our maximum contribution to Roth IRA is pegged at $6,000 each, so this fits nicely into our new budget. Is this a wise move for us since I am 59 and my wife is 54?

SUNIL, MINNEAPOLIS

A Clearly, you are good savers and it's terrific that you're turning mortgage payments into retirement savings. I think it's a good move. That said, let's peel the Roth onion to make sure it's a sensible choice for you and you're wife.

The big advantage of the Roth is since you've already paid tax on the money going in you don't have to pay taxes on accumulated gains when you withdraw money during retirement. The Roth also offers savers an "emergency" fund. You really don't want to take money out of your Roth, but in a pinch you can withdraw contributions tax-free and penalty-free.

The treatment of earnings in the Roth is different. There are two critical time limitations on withdrawing earnings tax- and penalty-free. First, you can't avoid the double whammy if you take the money out before age 59 1/2. You also can't take out gains tax free until the Roth is in existence for 5 years. The clock starts ticking on Jan. 1 of the year of your first Roth contribution. (It doesn't reset every time you make a contribution.)

There are a number of wrinkles to consider. For example, the case for a Roth is strong with your wife since she's younger and has more time for the earnings to compound. It's less obvious for you. However, an advantage of the Roth is unlike a traditional IRA and 401(k) there is no required minimum distribution at age 70 1/2. Is that important to you? On the other hand, a traditional IRA is funded with pretax dollars and you pay your ordinary income tax rate on the savings when it's withdrawn during retirement. The traditional IRAs is a more attractive retirement savings vehicle than the Roth if your tax bracket will be lower in retirement.

So, what's the bottom line? You can't really go wrong with the Roth. But the answer doesn't lie in evaluating the specific advantages and disadvantages of the Roth. It depends on how the Roth fits in with your other savings. Assuming that you have some taxable accounts you can tap in retirement and a tax-deferred retirement savings plan such as a 401(k), opening up a Roth offers you tax diversification and financial flexibility.

Chris Farrell is economics editor for "Marketplace Money." Send your questions to cfarrell@mpr.org.

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