By Martha M. Hamilton
Sunday, December 31, 2006

Andrew C. Baird III is off to a great start, already putting money into an employer-sponsored retirement savings account at age 22. But he wonders whether he would be better off steering his savings into a Roth individual retirement account outside of the workplace.

Baird, who graduated in May from Trinity College in Hartford, Conn., has been working at the Orvis Co. store in Clarendon. It has been a good temporary gig for him -- he's an avid fly fisherman -- while he looked for a more serious post-college direction. Orvis offers a 401(k) plan, and Baird is taking advantage of it, depositing about 10 percent of his income there.

"When you're getting paid hourly, that's a substantial amount," said Baird, who is living with his parents in Arlington.

Baird is on the brink of changing jobs, but he raised the question about switching his 401(k) money into a Roth IRA before the new opportunity came along. It was prompted by comments of a friend, who said he was switching to a Roth to have more control of investments and to be able to invest more aggressively. Both ideas appealed to Baird, though he doesn't have much money to manage right now -- about $400.

I put Baird's question to two experts on financial planning for retirement and asked them what others should consider when deciding whether to open a Roth IRA. If you qualify for a Roth IRA, you have until the tax filing deadline in April to make a contribution for 2006.

First let's spell out the basics. In a traditional IRA, deposits are made with pretax dollars. The money goes into savings, reducing your taxable income and therefore the taxes you pay. But after you withdraw the money at retirement, you pay taxes on your contributions and the money you've made through investments.

In a Roth IRA, the dollars you save already have been taxed, but when you start withdrawing money, both contributions and earnings will be tax-free, assuming you're 59 1/2 and the account has existed for five years. There are income limits on eligibility for a Roth IRA. (See box, above right).

You can contribute to a Roth IRA in addition to an employer-provided savings plan such as a 401(k). In the future many companies are likely to offer, as part of their 401(k) plans, a Roth 401(k) option that would not have income cutoffs. We won't get into the rules for those or for converting a traditional IRA to a Roth in this column.

Dallas Salisbury, who heads the Employee Benefit Research Institute, and Christine S. Fahlund, senior financial planner for T. Rowe Price, said there are several good reasons to invest in a Roth IRA if you are eligible.

It makes sense especially for someone like Baird, who is young and at the beginning of his career, because he is likely to be paying lower taxes now than in the future, possibly even in retirement. But investors in higher brackets may also face increased taxes in the future as Congress struggles to keep up with spending needs and to close the budget deficit.

Salisbury says he always tells his own family that the current budget situation, along with questions about long-term funding of Social Security, means there's a greater chance of future tax increases. With that in mind, "an individual is always going to be better off putting dollars that aren't matched into a Roth or a medical savings account, anything that says you won't pay taxes when it comes out," he said.

When Salisbury says "matched," he is talking about the matching contributions employers often make on behalf of participants in 401(k) plans, sometimes dollar for dollar up to a certain percentage of salary. If you have your money in a 401(k) plan with a company match, it makes sense to contribute enough to capture those matching funds.

"I think people of all ages should be thinking about Roth IRAs, especially those who are young," Fahlund said. Otherwise, if you put pretax money into a savings plan at age 20 and leave it in until age 70 1/2 when you are required to begin withdrawals, "you have been growing taxes for Uncle Sam" for 50 years. Only a portion is yours. That's useful to keep in mind when you look at those satisfying sums in your tax-deductible retirement savings account statements. It may be a nice pile of money, but it's not all yours.

"Even when you are in your 60s, I still think that if you can afford to contribute after-tax, that's what you want to be doing," Fahlund said. For one thing, there are no minimum distribution requirements on the Roth IRAs. You can leave that money untouched as long as you like, whether you live to be 90 or die before you need it. "That's a fabulous legacy to leave to your children or grandchildren," she said, "but if you need it, it's yours -- not three-quarters of it is yours and the rest is Uncle Sam's."

Additionally, there is no age limit for contributing to a Roth IRA. Assuming you have earned income, you can contribute past age 70 1/2 . Fahlund also notes that Roth IRAs are more flexible in some respects than tax-deductible IRAs or 401(k) accounts. You may withdraw your principal -- the amount you have contributed -- at any point, although there are restrictions on when you can withdraw earnings without paying taxes.

Once you turn 59 1/2 , you can withdraw the earnings in a Roth IRA tax-free as long as it has been five years since you made your first contribution to the account. And no matter when you make the contribution, even if it's on Dec. 31, it's counted as having been made on Jan. 1 of that year.

Though your tax rate may go down when you retire, tax-free income is still a good thing, said Fahlund.

"I haven't met a retiree yet who is not supersensitive to how much they're paying the government," she said of retirees taking distributions from traditional IRAs. "In the end, you really like to think of it as all yours."

Have you had trouble trying to withdraw money from your IRA after you've retired? If so, and you're willing to talk about it on the record, I'd like to hear from you. Please e-mail hamiltonm@washpost.com.