A Suze Orman exclusive

I cannot repeat this enough: If you are eligible to invest in a Roth IRA, I think it is hands down the best retirement investment you can make. (Quick recap: you may make the full $4,000 contribution to a Roth this year if you are single and your income is below $95,000, or if you are married filing a joint tax return and your household income is below $150,000.)The advantages of a Roth, especially when it comes to taxes, may not be immediately apparent. When you invest in a Roth, you see, you get absolutely no tax break. There is no deduction for your contribution; in fact, you invest in a Roth with money that has already been taxed. But before you decide I am nuts to push Roths, stick with me for a few more minutes.

The way our tax system works is that at some point all retirement money gets taxed. There is no free lunch. Your IRAs and 401(k)s are tax-deferred, not tax-free. “Deferred” is code for: “Uncle Sam will take his bite later.” So when you invest in a 401(k) with pre-tax money, you need to be aware there’s going to be a bill from the government somewhere down the line. Specifically, you will be required to pay tax on all your withdrawals when you retire.

But since you invest in a Roth with money that has already been taxed, you are free and clear of Uncle Sam. You already gave the federal government its bite. So when you reach retirement and start making withdrawals, there will be no tax. Zero. The only trick is that you need to be at least 59 ½ when you start the withdrawals, and your Roth account must be at least five years old.

And wait, it gets even better. The money you contribute to a Roth has no strings attached. You can pull it out next week, or next year, and there will be no tax and no early withdrawal penalty, regardless of your age. Why? Because it’s your money that you have already paid the tax on. That’s a nice bit of flexibility, eh? My strong suggestion is that you never touch your Roth assets before you retire, but I know life is full of unexpected turns. If you ever find yourself in a financial pickle, your contributions to your Roth can be tapped as an emergency cash fund.

The only money you can’t touch is the earnings in your Roth account. Yank that money and you will get hit with a 10 percent penalty.

When Regular Can Beat Special
We get so twisted in knots about tax breaks I think we overlook a really simple way to invest for our retirement: straightforward “regular” taxable investment accounts. If you own assets in a regular account for at least one year, when you go to sell, you will owe tax on any gain. But it will qualify for the long-term capital gains rate, which right now happens to be a super-low 15 percent. Remember, withdrawals from your 401(k) and traditional IRA will be taxed at your income tax rate, which can be as high as 35 percent. That’s a big, big difference.

Now the one trick to using a regular account is to not generate a tax bill during the period you are invested. Remember, with a regular account any time you move your money around it is considered a “sale” by the IRS and you will owe tax. Bottom line: you want to be a real buy-and-hold investor. Stick the money in an index fund or an ETF (Exchange-Traded Fund) and don’t touch it. Those of you who invest in mutual funds know that even if you don’t touch your account, you can still get a tax bill from the fund each year, because it is required to pass along its gain to shareholders. That’s why I recommend an index fund such as the Vanguard Total Stock Market fund. Index funds tend to generate no, or very small, tax bills. Even better, use an ETF, which operates like a stock; you are guaranteed not to have a tax bill until you sell your shares. The Vanguard VIPER (symbol: VTI) is the ETF version of the Total Market Fund.