Americans are living longer than ever, and retirement is getting more and more expensive as the cost of living and inflation continue to grow.
Several investment vehicles exist to help you save for retirement such as a Roth IRA.
What is a Roth IRA?
A Roth IRA is an individual retirement savings account that allows your money to grow tax-free. You put your after-tax dollars in a Roth IRA, meaning you’ve already paid taxes on the money you put into it. Since every penny in your Roth IRA is your own, your money grows tax free, and when you withdraw at retirement, you pay no taxes. The entire amount goes straight into your pocket.
You can contribute to a Roth IRA at any age as long as you have earned income from a job.
However, there are income eligibility limits. For example, if you make too much money, you can’t contribute to a Roth IRA. However, given the annual median household income of about $50,000 most Americans do qualify for Roth IRA contributions.
Benefits of a Roth IRA
There are several benefits of a Roth IRA which make this retirement vehicle so appealing.
A clear benefit of a Roth IRA is tax-free compounding, which means you don’t have to pay taxes on any capital gains or dividends on your investments.
In addition, any qualified withdrawals you make during retirement are tax-free.
You do receive a similar tax benefit with a traditional IRA. In addition to tax-free capital gains and dividends, a traditional IRA gives you an up-front tax break, as you may be able to deduct your contributions from your taxable income.
Therefore, the choice between the two account types comes down to whether you want your tax benefits now or in retirement.
One benefit of Roth IRA’s tax-free withdrawals is it protects you from income tax raises. If you’re still years or even decades from retirement, it’s likely you’ll be in a higher tax bracket when you retire, so it may be best to invest through a Roth IRA and forgo the up-front tax break.
No Minimum or Maximum Age Requirements For Contributions Or Withdrawals
Unlike other investment accounts like a traditional IRA which requires you to stop contributing and start making withdrawals at a particular age, a Roth IRA has no minimum or maximum age requirements.
With a Roth IRA, if you don’t need the money you can leave it in the investment and let it earn additional years of tax-free compounding.
Easy Withdrawals At Any Time
One of the exciting benefits of a Roth IRA is that you can withdraw money at any time for any reason unlike other types of retirement accounts. Other retirement plans such as a 401(k) and a traditional IRA only allow you to make early withdrawals under certain circumstances like financial hardship.
You can use your Roth IRA both as a retirement plan and as an emergency fund. For example, if you’ve contributed $10,000 to a Roth IRA each year for 20 years, you can access $200,000 of your savings whenever you need for whatever you need.
A Roth IRA lets you access your investment gains early without a penalty. You can withdraw gains from your investment to spend toward the purchase of your first home or to cover college education expenses.
However, if you choose to withdraw more than your original contributions early, you’ll have to pay income tax on the investment gains unless you are over 59 1/2 years of age.
Roth IRAs Can Be An Effective Estate Planning Tool
A Roth IRA can also be an effective estate planning tool because it allows you to let your money grow tax-free for your entire life as well as leave tax-free income to your beneficiaries.
Your beneficiaries will be subject to minimum distributions based on their age beginning in the year after you die. However, unlike the original account holder, the beneficiary cannot let money in an inherited Roth IRA compound tax-free indefinitely. The IRS publishes a list of “life expectancy factors” that are used to calculate the minimum distribution requirements.
A Roth IRA is a unique retirement savings tool and can be an essential part of your long-term financial planning. We’ve discussed several benefits of a Roth IRA above but as with all types of retirements plans there are advantages and disadvantages. Make sure you do your research before deciding which retirement savings vehicles are right for you.