Reasons to Invest in a Roth Ira before the 2011 Contribution Deadline

No one likes to pay taxes. A Roth Individual Retirement Account (IRA) is one of your best legal ways to avoid paying them.

A Roth IRA is a tax-friendly retirement savings plan which allows designated Roth contributions to the account. Unlike standard IRA contributions, which are pre-tax, designated Roth contributions are included in gross income. As a result, after paying tax on the original contributions, Roth IRAs allow you to earn interest and investment income on your Roth contributions, completely tax-free.

At a modest compound interest rate of just 5%, you can double your investment in just 14.2 years. Every 14.2 years, your investment will double again. If you start investing when you are 20 years old, your original investment will have grown to 8 times its original size by the time you reach age 63. If you manage to get 10% throughout, your original investment will have grown to 64 times its original size!

For 2011, the maximum amount which may be contributed to a Roth IRA per year is your earned income or $5,000, whichever is lower, with an additional $1,000 in catch-up contributions if you are 50 years of age or older at the end of the tax year. If you are 20 years old and invest $5,000 at just 5% interest, you will have earned over $35,000 of tax-free income by the time you are 63 years old, and that’s just on your 2011 contribution.

This is too good a tax shelter to overlook accidentally. Unfortunately, if you only remember about it when you tackle your income tax return next April, it’s already too late. Even leaving it until December runs the risk of forgetting amid the holiday rush. If you do not use the full amount of your IRA contribution limit in 2011, the difference does not carry over into 2012.

The easiest way to avoid this calamity is to set up an automatic contribution plan into your Roth IRA. After all, contributions to your Roth IRA do not have to be added into the account in one lump sum. Instead, you might choose to divide your contribution into smaller payments over the course of the year. Small monthly payments of $416.66 are much easier to handle than a single lump-sum payment of $5,000.

However, you get the best benefit out of your Roth IRA if you pay into it right at the beginning of the tax year. That way, you get nearly a year’s head start on earning tax-free interest. Most financial institutions will allow you to set up an automatic contribution plan which transfers the 2011 maximum contribution into your Roth IRA at the beginning of every year.

If your Modified Adjusted Gross Income (MAGI) is close to the Roth IRA income limit, it is even more important not to leave your full Roth IRA contribution until the deadline. You will have some calculating to do in order to know the exact amount of contribution you will be allowed. You will want to come as close as you can to your full allowed contribution, without going over. These kinds of calculations are not something you want to leave until the last minute, especially during holiday season.