There are a lot of options when deciding where to grow your retirement savings. If you’re eligible, the Roth IRA may just be at the top of the list. A Roth IRA is an individual retirement account that offers tax free withdrawals in retirement. You do pay taxes on the money you contribute to the account, but the earnings are tax free. If that’s not enough reason, there are a few more to explore the benefits of a Roth IRA.
Advantages and Benefits of a Roth IRA
The biggest advantage of the Roth IRA is the tax free growth and tax free withdrawals in retirement. This advantage can be a huge benefit, here is why.
Scenario One:
Invest $6,000 per year, only $500 per month, for 30 years.
Final Value of the Roth IRA: $658,684
Interest Earned Tax Free: $472,684
Initial investment that was taxed: $186,000
Scenario Two:
Invest $6,000 per year for 20 years.
Final Value of the Roth IRA: $284,696
Interest Earned Tax Free: $158,696
Initial investment that was taxed: $126,000
Both assume 7% interest. As you can see, the earlier you start the better off you will be in retirement to take advantage of the benefits of a Roth IRA. However, even when you invest in a Roth IRA for a shorter period of time, you will still save a lot on taxes when you withdraw during your retirement.
No Age Limit
There is no age limit to fund you Roth IRA, as long as you have earned income that qualifies.
No Required Minimum Distributions (RMD)
Additional benefits of a Roth IRA, unlike the traditional IRA, the Roth has zero RMD for as long as you live.
Zero Taxes for Your Beneficiaries
If you pass before all your withdrawals are taken, your Roth IRA is passed to your beneficiaries and their withdrawals will be tax free. However, the beneficiaries will have to take the Required Minimum Distribution assuming the original account owner held the funds for at least 5 years.
Addition to Employer Plan
You may still contribute to a Roth IRA even if you contribute to your employer’s retirement plan, such as a 401(k), 403(b), or 457. Of course, the IRS’s income limits still apply (we will cover that later).
Withdrawal Early
If you find yourself strapped for cash, you may withdraw your contributions early without fee or penalty. This is for just the contribution, not the interest earned since that contribution. You may be charged tax or penalties if you withdraw the interest. Of course, this should be a last resort as you will be losing out on any additional tax-free earnings from those contributions.
Additional Time to Contribute
You have until the tax deadline to contribute for last year’s contribution.
Roth IRA Restrictions
Income Limits
In order to contribute to a Roth IRA for 2021, your modified adjusted gross income must be under $140,000 for single filers, and under $208,000 for filing jointly. There is a way around this rule called the backdoor Roth IRA. Basically, you would contribute to a traditional IRA and then convert it to a Roth. There are a lot of variables with this strategy and it may be worth investigating if you fall into this category. However, you may want to consult your tax advisor for specifics.
Contribution Limits
For the tax years of 2020 and 2021, may only contribute up to $6,000 ($7,000 if you are 50 or older) per year.
Other Restrictions
You need to own the account for at least 5 years and be age 59 ½ or older to withdraw the money with interest to not pay any federal taxes. Also, contributions to the Roth IRA are not tax deductible.
How to Open a Roth IRA
You can open a Roth IRA at a bank or brokerage firm. You have a lot of options to choose what you want to invest your money in, stocks, bonds, mutual funds, exchange traded funds or other bank products. How much risk you want to take may depend on how close you are to retirement. The younger you are, the more risk you can take. That’s because you’ll want to take advantage of the reward for higher, riskier investments but also have more time to recover in case of a downturn. That’s a good reminder that you can lose money in a Roth IRA, just like other investments, so be sure to diversify to minimize the risk.
In closing, the Roth IRA should be a part of your retirement portfolio due to the tax benefits. If you only have pre-tax investments you will have a hefty tax bill on those withdrawals. The Roth IRA allows you to off-set those taxable assets with a tax-free option. Check out the IRS website for all the legal aspects of the Roth IRA. These tips are not meant to be tax or investment advice. Please see a professional advisor or be sure to do your own research before investing.
Check out our Retirement Saving Tips article for even more ways to save for retirement.
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