ROTH IRA BENEFITS
Feeling a bit overwhelmed by retirement planning? Trust me, I’ve been there, too. With all the different accounts and confusing terms 401(k), IRA, and 403(b), it’s easy to get confused. But then I discovered the Roth IRA, a gem in the personal finance world that can streamline your path to financial wellness.
In this post I’ll break down Roth IRA benefits and why they might be your new best friend in retirement planning, especially if you’re just starting out.
What Is A Roth IRA?
First, let’s get the basics down. A Roth IRA (individual retirement account) is a kind of savings account with some pretty sweet perks. Here’s the scoop: you fund the account with after-tax dollars. This means you pay taxes on that money before it goes into your Roth IRA account. But, once it’s there, it grows tax-free. And when you retire, you can withdraw the money without paying a dime in taxes. Pretty awesome, right?
Now that we’ve covered the basic idea of a Roth IRA, let’s take a closer look into why it’s such a hit in the world of retirement savings.
8 Benefits of a Roth IRA
1. Tax-free growth
One of the best things about having a Roth IRA is tax-free growth. When you invest in a Roth IRA, any earnings and growth from these investments are NOT taxed. This means all the dividends, interest, and capital gains your money earns are yours to keep.
Over time, this means you can build wealth more efficiently since you won’t owe taxes on your investments when you withdraw. This long-term advantage can hugely increase your retirement savings. And by the time you retire, you can enjoy the fruits of your labor because you’ll be able to appreciate that tax-free cash.
2. Tax Withdrawal
Another key benefit of a Roth IRA is that when you withdraw your money, you don’t have to pay taxes on it. Because you’ve already paid taxes on the contributions, you can withdraw the money tax-free in retirement.
This can give you some peace of mind, especially if taxes increase in the future.
3. Flexible Investment options
A Roth IRA offers a wider range of investment options, like stocks, bonds, mutual funds, and ETFs. This variety of funds lets you tailor your investment strategy to your specific goals and risk tolerance.
If your investment strategy is more conservative, you can choose more stable investments like bonds or dividend-paying stocks. If you’re able to tolerate more risk, and focused on growth, then you can invest in more growth-focused stocks or ETFs.
On the flip side, traditional retirement plans offered by your employer, like the 401(k), tend to have more limited investment options.
The flexibility of choosing your own investments means you can be better in control of your retirement goals.
4. No required minimum distributions (RMDs)
Required Minimum Distributions are the minimum amounts a retirement account owner must withdraw annually from their account starting at a certain age.
Unlike traditional retirement accounts, Roth IRAs don’t force you to start taking money out at age 73. This gives you the freedom to let your money keep growing tax-free as long as you want.
5. Easy Withdrawals
Another great feature of a Roth IRA is the access it allows to your contributions. Since you’ve already paid taxes on the money you contributed, you can withdraw those contributions (not gains) without dealing with penalties or taxes.
I’m not saying you should do this since it would affect your money compounding, but this could be useful if you find yourself in an unexpected situation or emergency where you need those funds right away.
6. Self-accessible
Roth IRAs give you better access to your money than traditional employer-sponsored retirement plans. You don’t need to go through your employer to open the account; you can do it yourself.
Back then, you had to hire a broker to do all this for you. Nowadays, you can manage your account and track its performance whenever you want, thanks to online accessibility and apps.
With these tools, you can monitor your investments, contribute, withdraw, or adjust your strategy, all from the couch. This easy access helps you handle your financial business quickly whenever it pops up, making it a good choice for smart investors.
7. You Can Keep Contributing After Retirement
Here’s something really cool: as long as you still have earned income, you can keep contributing money to your Roth IRA even after you hit 59 1/2. Lots of retirement accounts make you stop contributing once you reach a certain age, but not Roth IRAs.
Continuing to make contributions can boost your savings even more. Giving you more financial flexibility and security later on. Plus, if you enjoy working and want to stay active, being able to put money into your Roth IRA means you’re not just limited to what you saved up before retirement—you can keep adding to your savings as you go.
8. Estate Planning
Here’s something you might not have considered: Roth IRAs can help leave loved ones with financial inheritance. If you’ve ever thought about passing money to your heirs, a Roth IRA can be a tax-advantaged option.
When your beneficiaries inherit the account, they can generally take the distributions without paying taxes on that money. Meaning they get to keep more of what you worked to build. Spouses can even treat inherited Roth IRAs as their own.
It’s a great way to support family even after you’re gone; knowing that you’re setting them up for success can give you more comfort.
Roth IRA Eligibility and Contributions Limits
For Roth IRAs, there are some eligibility requirements to keep in mind.
First, you need to have earned taxable income. This includes wages, salaries, tips, or self-employment income. So no, you can’t fund an IRA only on investment income or passive income like rental profits.
As of 2024, the contribution limits for a Roth IRA are $7,000 if you’re under 50, and catch-up contributions for age 50 or older are $8,000.
Keep in mind that there are also income limits on Roth contributions, so make sure you check if you qualify. Over-contributing can lead to penalties, so be aware of these limits. Contribution limits change, which is why it’s crucial to stay updated with the latest IRS guidelines.
Backdoor Roth IRA
If your income limit exceeds the limits to contribute directly to a Roth IRA, don’t worry; there’s a loophole for you! This is where the backdoor Roth IRA comes into play. This entirely legal strategy allows you to contribute to a traditional IRA first and then convert those funds into a Roth IRA.
It’s a sweet option for high earners to take advantage of Roth IRA benefits.
That said, I am not a tax professional, and it’s important to move forward carefully. There are specific rules and potential tax implications involved with this process. If you’re considering using a backdoor Roth IRA, consult with a CPA. They can help ensure you understand the intricacies and make the best choices for your financial situation.
Roth IRA Drawbacks
Income Limits
Like I said earlier in this post, Roth IRAs have specific cutoffs that restrict people with a higher income from contributing directly to the account. For the 2024 tax year, single filers with modified adjusted gross incomes (MAGI) above $153,000 and married couples filing jointly with MAGI above $228,000 have reduced contribution limits or may not be able to contribute at all.
No Tax Deduction on Contributions
Since the Roth IRA is funded with after-tax dollars. This means that you don’t get an immediate tax deduction for your contributions. Some would consider this a disadvantage if you’re trying to lower your taxable income for the year.
Restriction on Earning Withdrawals
To withdraw earnings tax-free from your Roth IRA, you have to be at least 59 1/2 years old and maintain your account for at least 5 years.
Lower Contribution Limits than other Retirement Accounts
For 2024, the maximum annual contribution is $6,500, or $7,500 for individuals aged 50 and over. This is lower than traditional retirement accounts where the max contribution limits for 2024 is $ 23,000.
Tax Obligations
Contributing to a Roth IRA does not allow you the same tax advantages as a traditional retirement account. Even though earnings grow tax-free, contributions are taxed upfront.
Either way, you have to pay Uncle Sam. So, the decision is yours. People who are in a lower tax bracket may be better off contributing to a Roth IRA now since they don’t need the tax deduction as badly. But people in a higher tax bracket that are trying to lower their taxable income might think it’s a better idea to use a tax-deferred retirement account.
Another important thought is whether you expect to earn the same amount of money in retirement as you do now. Take some time to think about what tax bracket you’ll be in during retirement. If you anticipate being in a lower tax bracket, you’ll likely pay less in taxes on your withdrawals. In this case, focusing on tax-deferred retirement accounts now may be more beneficial to you.
Steps to Open a Roth IRA
- Choose an institution
Start by choosing a provider that offers Roth IRAs—options like Vanguard, Fidelity, or Charles Schwab. When deciding which company to go with, think about things like fees, investment options, and customer service. - Collect Your Info
To open an account, you’ll need all your personal information, like your Social security number, address, birthday, and employment details. - Complete the Application
Visit your chosen institution’s website or branch location to complete an application. This can usually be done online, making it super convenient for customers. Make sure you choose the Roth IRA option. - Fund Your Account
After your account is opened, you’ll have to make the contributions. You can do this by direct deposit, bank transfers, or rollover from traditional IRAs. - Choose Your Investments
Once your funds have hit your account, it’s time to choose your investments. You can choose from stocks, bonds, mutual funds, or ETFs. - Track Your Account
Take a look at your account from time to time. Make sure your investments are still in line with your retirement goals. As you get closer to retirement or your goals change, you may need to make some adjustments based on your financial situation.
Roth IRA Common Mistakes to Avoid
Choosing Your Investments
Okay, I’m putting this one as #1 because I always hear about it happening—forgetting to invest the money in your Roth IRA. Once you fund your account, it’s ESSENTIAL to choose your investments within the Roth IRA.
Funding the account without taking this step is a mistake a lot of people make, only to realize it years later when potential gains have already been lost. If you let the money sit there without investing it, it won’t grow! Make sure to actively choose investment options that fit your financial goals to get the most out of your account’s potential.
Not Naming Beneficiaries
Not naming beneficiaries for your account can lead to complications down the line and a lag in distributing your assets if you pass. Make sure to name beneficiaries for your Roth IRA account and all your accounts, for that matter.
Over Contributing
Over-contributing can have serious consequences if you earn over the income limits for Roth IRA contributions. When you put more money into your Roth IRA than you’re allowed, you might have to deal with tax penalties and complications in the future. The IRS puts a 6% excess contribution penalty for each year that the excess amount remains in your account.
To avoid this, monitoring your income and making sure you stay within the limits is crucial. If you accidentally over-contribute, you may need to withdraw the excess contributions and any earnings on them to cut down on penalties. Understanding these rules can help you avoid extra costs and keep your retirement savings on track.
Early Withdrawl on Earnings
Withdrawing earnings from your Roth IRA before you turn 59½ or before the account is at least five years old can lead to expensive consequences. If you make an early withdrawal, you’ll most likely have to deal with taxes on the earnings, PLUS a 10% penalty on top of that.
This can eat into your retirement savings. The key is to remember that Roth IRAs are designed for long-term growth, so it’s best to keep your earnings in the account until you meet the withdrawal criteria.
Saving your earnings for retirement allows your money to grow tax-free, ensuring you have more to rely on when you need it most. Always think twice before taking that money out too soon!
Not Contributing to a Roth IRA Because You Already Have a Traditional Retirement Account
Many people make the mistake of thinking they don’t need to open a Roth IRA just because they already have a 401(k) or a traditional IRA. While these accounts are valuable for retirement savings, they have different benefits and limitations. By forgetting about contributing to a Roth IRA, you might miss out on tax advantages, like tax-free growth and tax-free retirement withdrawal.
Even if you’re maxing out your 401(k) contributions, contributing to a Roth IRA can help you save more for the future, especially if you predict being in a higher tax bracket later on. Don’t miss out on this opportunity to diversify your retirement savings and enhance your financial strategy.
Final Thoughts on Reasons to Invest in a Roth IRA
At the end of the day, contributing to a Roth IRA can be one of the smartest moves you can make for your financial future. With tax-free growth and being able to withdraw contributions without penalty, it’s one of the best ways to build up your nest egg for retirement.
So, if you haven’t already, take a sec to evaluate your options. You may be better off chatting with a CPA or financial advisor. And don’t hesitate to take those important steps towards securing your financial future.
Resources:
Charles Schwab
Fidelity
Internal Revenue Service (IRS)
Vanguard