Do you like paying more in taxes? Do you like keeping more of your money? What’s all the rage with Roth IRAs you might ask? Let us shed a little light in the next 5 minutes on the subject.
While Traditional IRAs and Roth IRAs have some of the same rules and characteristics, there are several key differences which makes the Roth IRA a great option for investors to consider. Let’s take a look at what makes the Roth IRA stand out from other investment options.
First, what is a Roth IRA? A Roth IRA is an individual retirement account that is funded with after-tax dollars contributions. What does after-tax mean? Think of it as the money that has already hit your bank account that you have paid taxes on through your employer payroll. After-tax is what is left that you can spend. This means that the investor has already paid taxes on the money they are putting in the Roth IRA and contributions as well as earnings grow tax-free. The potential tax-free growth of earnings can be very advantageous for younger investors, especially since most individuals tend to be in a lower tax bracket in the earlier stages of life. Additionally, you can continue to contribute to a Roth IRA at any age if you have earned income. Think of “earned income” as money from wages from a job with an employer or money from your own business you run. This makes the Roth IRA a smart option for those who wish to continue working and retire later in life.
How about withdrawals or if I need access to money?
Since taxes are paid upfront and out of the way, any distributions from a Roth IRA would be free from federal taxes once a few conditions are met. If the account owner is age of 59 ½ or older and the funds have been held in the account for 5 years or more, or if the account owner becomes disabled, any distributions from a Roth IRA are tax-free. However, even if these requirements are not met (things are not so bad), account owners can still take funds from the accounts if needed. Roth IRA owners can withdraw all contributions made into the account at any time penalty and tax-free for any reason. Any earnings/growth or converted funds may be subject to restrictions, however.
Not only are qualified withdrawals tax-free, but they are not even required, like they are with many other retirement accounts. You can let your money grow as long as you want without anyone forcing you to take money out! In many other common retirement accounts such as 401ks, Simple IRAs, SEP IRAs, Thrift Savings Plans, etc. …you are forced to take money out and pay taxes when you hit a certain age. Currently that age is 73 and changes over time with legislation. These distributions are referred to as Required Minimum Distributions (RMDs).
Are there any other benefits to a Roth? Certainly! Roth IRAs have named beneficiaries, making them a great estate planning tool. Unlike when you are living, beneficiaries who inherit a Roth IRA are required to take required minimum distributions, however the withdrawals are not subject to federal taxes like they are for beneficiaries who inherit Traditional IRAs and other qualified retirement accounts. This helps ease the worries investors have when it comes to estate planning and provides individuals the chance to leave more of a legacy for their loved ones.
While it is important to make sure you understand all the investment options available and consult a professional, it is clear to see how opening a Roth IRA can be beneficial for all investors at any stage of life. This article was written in collaboration with Aaron Hill, CFP® MBA.