Мaximize the benefits of Roth IRA

Roth IRA is a tax-exempt investment account that allows the owner to make after-tax contributions to save for retirement.  The plan has a tax free status. All investments grow tax-free. The Roth IRA offers a lot of flexibility and few constraints.  There are numerous ways to maximize the benefits of the Roth IRA.

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Save for the future. Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those with who have 401k plans with their employer can open a Roth IRA.

Flexibility. There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well.

No investment restrictions. There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes. There are no taxes on the distributions from this account once the owner reaches the age of 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either. 

No penalties if you withdraw your original investment. While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Roth IRA helps you diversify your future tax exposure. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Naturally, nobody can predict what will happen in several years or decades. Nobody knows how the tax laws will change by the time they need to take out money from the account. That is why I highly recommend devitrifying your mix of investment accounts and take full advantage of your Roth IRA.

Roth IRA is ideal for investors who are in a lower tax bracket but expect to jump in a higher one when they retire. Naturally, nobody can predict what will happen in several years or decades. Nobody knows how the tax laws will change by the time they need to take out money from the account. That is why I highly recommend devitrifying your mix of investment accounts and take full advantage of your Roth IRA.

No minimum distributions.  Unlike 401k plans, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Roth IRA has two main restrictions. First, you can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

Second, you can only contribute up to $5,500 plus a catch-up $1,000 per year if you make $117,000 and under for 2016 tax year.

Since Roth IRA enjoys a special tax status, there are several ways to capitalize on these benefits.

1. Maximize your contribution

If you earn $117,000 or less, you can contribute up to $5,500 per year. Individuals 50 years old and above can add a catch-up contribution of $1,000.

If your aggregated gross income is between $117,000 and $131,999 you can still make contributions but with decreasing value. The chart below will help you determine how much you can add if your income falls within this range.

 117,000 and under 5,500 1,000 6,500
 118,000 5,133 1,000 6,133
 119,000 4,767 1,000 5,767
 120,000 4,400 1,000 5,400
 121,000 4,033 1,000 5,033
 122,000 3,667 1,000 4,667
 123,000 3,300 1,000 4,300
 124,000 2,933 1,000 3,933
 125,000 2,567 1,000 3,567
 126,000 2,200 1,000 3,200
 127,000 1,833 1,000 2,833
 128,000 1,467 1,000 2,467
 129,000 1,100 1,000 2,100
 130,000 733 1,000 1,733
 131,000 367 1,000 1,367
 132,000 – –

2. Start early

To maximize the full potential of Roth IRA, you need to start saving early. With an average historical growth rate of 7%, your investment of $5,500 today can bring you $41,867 in 30 years completely tax-free. The cumulative effect of your return and the tax status of the account will help your investments grow faster.

Roth IRA is an excellent starting point for young professionals who just start their career. If you make under $117k, you are in your full right to invest the full amount of $5,500.

Minors who earn income can also invest in Roth IRA. While youngsters have fewer opportunities to make money, there are some that will count – babysitting, garden cleaning, child acting, modeling, selling lemonade, distributing papers, etc.

If you can only afford to save $5,500 this year, put them in Roth IRA.

3. Rollover from Traditional IRA and 401k plans

Under certain circumstances, it makes sense to rollover assets from your Traditional IRA and old 401k  accounts to Roth IRA. If you expect to earn less income or pay lower taxes in a particular year, it could be beneficial to consider Roth IRA rollover. Your rollover amount will be taxable at your current ordinary income tax level.

Another strategy is to consider annual rollovers in amounts that will keep you within your tax bracket.

4. Do a Backdoor rollover

Due to recent legal changes investors who do not satisfy the requirements for direct Roth IRA contributions, can still make investments to it. The process starts with taxable contributions, up to the annual limit, into a Traditional IRA. Eventually, the contributions are rolled from the Traditional IRA to the Roth IRA.

5. Best way to manage your Roth IRA

If the Roth IRA holds the bulk of your retirement savings, you have to maintain a diversified portfolio that is in line with your risk tolerance and financial goals.

However, due to the set contribution limits, Roth IRA accounts tend to be smaller relative to other investment accounts. In this case, you can take a more holistic approach and overweight certain assets in the Roth IRA, by maintaining your overall assets allocation within your risk tolerance level and financial targets.

How to invest 

Growth investments

The favorable tax status of the Roth IRA gives the advantage to high growth investments. Large-cap and small-cap growth and emerging market stocks are one of the most fittings investments for Roth IRA accounts. These investments have a common characteristic. They have higher than average expected future returns.

When you overweight these investments in your Roth IRA, you will avoid paying significant capital gain taxes if your investments were in the regular taxable account or high-income taxes if your investments were in a tax-deferred account like 401k.

High-yielding securities

Investments paying large distributions like high yield bonds, emerging market bonds, and REITs are also a good match for the Roth IRA. These investments generate above-average distributions taxable at the ordinary income rate. Placing them in your Roth IRA will shelter their income from taxes and let them grow tax-free.


Commodities investments including Gold have complex taxation rules. Gold ETFs like GLD and IAU are taxed as collectibles with 28% for long-term capital gains. Commodity ETFs are taxed at the 60/40 rule, 60% long-term, 40% short term (20% max/39.6% max) regardless of holding period. Commodity ETNs are taxed at 20% max for the long-term capital gain and 39.6% for short-term gains. Having commodity investments in your Roth IRA account will let you protect their return from these complex taxation rules.

Active mutual funds

Active mutual funds have higher turnover than ETFs and index funds. Therefore they often release capital gains to their shareholders. The short-term capital gains are taxable as ordinary income plus 3.8% Medicare surcharge. While long-term gains are taxed at the lower long-term capital gain rate of 0%, 15% or 20% plus 3.8% Medicare surcharge.

When these funds sit in your Roth IRA account, they will not trigger any taxes when the management releases the gains.

What to avoid

Tax-Exempt Municipal Bonds

The interest on tax-exempt municipal bonds is free from Federal and in some cases state taxes. These instruments are most suitable for taxable accounts where investors can take advantage of the favorable tax treatment. The benefit is not available if the municipal bonds sit in a Roth IRA account.

Investors interested in Municipal bond exposure in their Roth IRA may consider taxable municipal bonds. Their distributions are taxable at the ordinary income level. Hence you will avoid paying taxes on those investments.


Managed Limited Partnerships (MLPs) distribute at least 90% of their income to their partners. MLPs are attractive for their dividends. Also, on average 80% of the income payout is in the form of a tax-deferred return of capital. These type of distributions reduce the cost basis of the owenership and create a huge tax benefit for buy-and-hold investors. They will pay capital gain taxes on their shares only at the time of sale. However, this tax benefit will disappear if the MLP holdings sit in a Roth IRA account. They will lose their tax advantage status.

Furthermore, distributions that exceed $1,000 for each unitholder are considered unrelated business taxable income, or UBTI, and are subject to taxes even while in Roth IRA account.

Investors interested in MLPs for their Roth IRA should consider buying exchange-traded funds and mutual funds. They provide diversified exposure to MLPs and are not subject to the UBTI rule.

About the author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions.  Various sources may provide different figures due to variations in methodology and timing. Image copyright: 123RF.com


About Stoyan Panayotov

I am a fee-only financial advisor and the founder of Babylon Wealth Management. As fiduciary advisors, we provide bespoke wealth management and personalized financial planning to busy families in the Bay Area and nationally. Many of our clients are tech workers, physicians, business owners, professionals preparing for retirement and young families looking to build financial independence.

I started Babylon Wealth Management to help young families and successful professionals build, grow and preserve their wealth. Being a fee-only financial advisor, I never earn sales commissions or sell investment products. Furthermore, I am committed to acting in my clients’ best interest by providing trusted advice and bespoke wealth management solutions. I enjoy helping clients develop robust and personalized long-term financial plans to achieve their personal and financial goals.

After completing a bachelor’s degree in Accounting at Varna University of Economics in Bulgaria, at the age of 23, I moved to New York City to pursue a Master of Business Administration at Pace University. I was fortunate enough to have a full merit-based scholarship and finished graduate school with no student loans. Upon completing grad school, I joined the ranks on Wall Street for nearly two years. I specialized in risk management and option strategies for equity and fixed income products for Deutsche Bank and Wells Fargo. In 2006 I obtained a highly recognized CFA designation.

Living in New York without family support was a life-changing experience for me. II arrived at JFK Airport on August 24, 2002. I stayed in a hostel for two weeks and later moved in with three of my fellow Bulgarian students into a one-bedroom apartment in the Bronx. There was a time in life when all I owned was $200, just enough to pay for the next month’s rent. Many times, I contemplated returning to Bulgaria, but somehow, I always pushed through life’s adversities. I’ve learned to appreciate each moment, big or small, that life presents. These challenges have helped me develop strength and flexibility, which supports my practice as a financial advisor.

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