Most people are familiar with traditional IRAs. There’s a good chance you’re already using one to plan for retirement. While there’s a lot to be gained by using the traditional version, another retirement investment option is a Roth IRA. Let’s dive in a little deeper and help you weigh the benefits and drawbacks of a Roth IRA.
What is a Roth IRA?
A Roth IRA is a retirement savings account that allows you to pay taxes on the money you put
into it up front. The growth in your Roth IRA and any withdrawals you make after age 59 1/2
are tax-free, as long as you’ve had the account more than five years.
Advantages of a Roth IRA
Before you spend any more money on another investment vehicle, consider how a Roth IRA could help you better plan for retirement with these unique advantages.
- A Tax-Free Income Source in Retirement
The most popular benefit of investing in a Roth IRA is that, while you pay taxes on your contributions now, you don’t have to worry about taxes when you withdraw your contributions later. This helps your retirement savings go a lot further. Note that withdrawing contributions is different from withdrawing earnings, which may incur taxes and a 10% penalty.
- It Can Help in an Emergency
You can withdraw contributions from your Roth IRA whenever you want without suffering any penalty fees. Although you should use a Roth IRA with only retirement in mind, many investors do enjoy knowing they could tap this vehicle in case of an emergency. If you want to withdraw past your contribution amount, you have to be 59 ½ years old and your Roth IRA must have been opened at least five years ago. Some exceptions apply like if you’re paying for qualified education expenses.
- There Are No Minimum Distributions
One of the drawbacks of using a traditional IRA is that you can’t make contributions once you reach the age of 70 ½. At that point, the IRS forces you to begin taking distributions, which means paying taxes on those savings. However, with a Roth IRA, there are no mandatory minimum distributions while you’re alive. You could live to be100 without ever touching your money, which is a huge advantage as far as your estate planning goes. If you choose to work past retirement, you can also keep contributing up to the maximum contribution limit of $6,000 or $7,000 if you’re age 50 or older to your Roth IRA, as long as your income still falls within the income limits.
- It’s Better for Your Heirs
If you have loved ones to consider when it comes to financial planning, a Roth IRA is ideal. You can leave large sums of money – tax-free money – that they can enjoy for as long as the funds last. The tradeoff is that you’ll have to deal with taxes now, but if you’ll be leaving money for your loved ones, planning ahead for this burden could leave ample sums for your heirs.
- The Backdoor Strategy
The IRS restricts high-income earners from making contributions to Roth IRAs. Fortunately, there’s a way around this restriction. If you’re a high-income earner, you can simply make non-deductible contributions to traditional IRAs. Then, you do a Roth conversion and that money is essentially “back-doored” into this new account with all its benefits intact. Of course, it’s not that simple. The IRS requires that you consider all of your pretax holdings when calculating the tax liability of doing one of these conversions. This is a complicated process, which is why it’s best to have a professional handle it for you.
Drawbacks of a Roth IRA
While there are many benefits to a Roth IRA, there are some drawbacks as well. Before opening an account, it’s important to understand the disadvantages of a Roth IRA.
- Not Tax Deductible
Any contributions you make to a Roth IRA are not tax deductible, so you won’t be able to save money on your yearly taxes. A traditional IRA, on the other hand, is tax deductible.
- Contributions Don’t Reduce Your Gross Income
Money contributed to a Roth IRA doesn’t reduce your gross income, so you won’t be able to receive other tax breaks as a result of showing a lower income. Traditional IRA’s do reduce your gross income giving you access to a variety of tax breaks.
- High-Income Limits
Unlike traditional IRAs, if your income exceeds a certain amount you are not eligible to contribute to an IRA. If filing single, the limit is $121,000 and if filing jointly the limit is $192,000. This can cause problems with your retirement accounts if you opened a Roth IRA and then your income grows beyond the contribution eligibility limits. It’s worth noting the “backdoor” strategy is a way around this hurdle.
Want Help Setting Up Your Roth IRA?
Depending on your income level and other financial plans, a Roth IRA could be suitable for helping you reach your retirement goals. Contact us today and we’d be happy to talk about whether a Roth IRA or some other vehicle would be best for your unique needs.