Saving up for retirement is one of the optimal ways to ensure that you have enough money to live once you leave work for the last time. With a Roth Individual Retirement Account (Roth IRA), you can save for the future while you still earn and make your retirement savings work for you. In addition, the benefits of a Roth IRA make it a good investment vehicle, assuming you qualify.
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What is a Roth IRA and Why Should You Have One?
Roth IRAs are a popular type of retirement account for individuals. Creating a solid retirement plan is essential if you are in the healthcare field or specific other industries. The accounts are populated with money after the taxes on those funds have been paid. The benefit of these types of accounts is that you can grow your savings tax-free, and your withdrawals will also be tax-free once you have retired. This is a significant difference in the comparison between a Roth vs. a traditional IRA. On the other hand, contributions to traditional IRAs are tax deductible.
If you are interested in opening a Roth IRA, there are some caveats to keep in mind. Aside from eligibility requirements, checking your employment contract is one way to ascertain if you will qualify for a Roth IRA. Physicians and workers in other high earning professions should make sure they actually qualify because a Roth IRA has income restrictions.
Overall, Roth IRA accounts offer great benefits regardless of your length of employment or industry of employment. We have compiled a list of 8 key benefits of opening a Roth IRA.
Benefits of a Roth IRA
Retirement Withdrawals Are Tax-Free
For people who have maintained a Roth IRA for at least five years and reached the age of 59-½, withdrawals have no tax penalties. This fact means that both capital gains and contributions can be withdrawn without having to pay additional taxes.
People looking to withdraw a lump sum for a large purchase, vacation, or even investment can access their savings without sacrificing any penalties. One of the main benefits of this Roth IRA feature is that the withdrawals won’t increase your tax liabilities or affect your Medicare and Social Security benefits.
Grow Your Savings Tax-Free
The money invested in a Roth IRA will grow without taxation. This means that you don’t have to report your gains as investment earnings, and it won’t increase the amount of tax you pay each year.
Stephan Shipe, Ph.D., CFA, CFP®, the owner of Scholar Financial Advising, LLC, says,
“…having a Roth account gives you space to include high expected growth assets like small cap stocks or emerging markets. Overtime, these assets have the highest expected growth and their growth will be tax free.”
However, other investment accounts that result in gains must be reported for federal and state taxation. This allows you to truly invest in your future based on the earnings you are making today. After all, no one likes to pay the tax man twice!
Boost Your Savings by Opening a 401(k) and a Roth IRA
A lot of people need clarification regarding retirement savings. Too often, those looking to save for the future think they much choose between a 401(k) and a Roth IRA when you can do both. Of course, there are some income limits, contribution limits, and qualifications to keep in mind, but most people are eligible for both savings options. By combining your retirement into both a Roth IRA and a 401(k), your retirement wealth will be on track to grow by leaps and bounds in the future.
Diverse Investment Options
When you open a Roth IRA, the world is your oyster regarding investment options. Many retirement plans are tied to specific asset managers and employers. However, you can pick from a wide range of ETFs or mutual funds with Roth IRAs. Roth IRA account owners can also invest in bonds, funds, and individual stocks from a large selection of asset managers.
A Roth IRA Can Increase Your Tax Breaks
Anyone who adds eligible contributions to a Roth IRA, employer-sponsored 401(k), and certain other retirement funds are eligible for some specific tax breaks. For example, the Savers Credit also referred to as the Retirement Savings Contribution Credit, is one of the best tax discounts a Roth IRA can bring to your savings efforts. Of course, like with most tax breaks, adjusted gross income (AGI) and contributions will determine your eligibility.
Withdrawals Schedules are Completely Up to You
A traditional IRA has a required minimum distribution (RMD); however, Roth IRAs do not if you are the original owner based on information from the Internal Revenue Service (IRS). You can withdraw without penalty or additional taxation on any amounts you have personally contributed.
According to Cecil Staton, CFP® CSLP® of Arch Financial Planning, LLC,
“My favorite benefit of the Roth IRA is that you can pull your contributions from your Roth IRA at any time without tax or penalties. For early career professionals, this can be a huge benefit when cash is needed for emergencies.”
It is worth mentioning that there will be a withdrawal fee on earnings if you are under the age limit of 59-½. The best option is to contribute for as long as possible to allow your savings to compound. This will enable you to generate health returns when you need them.
That being said, if you do need to make a withdrawal, it is okay to do so and pay minimal penalties. Also, remember that any earnings your contributions generated can be withdrawn penalty-free upon retirement. However, the downside to early withdrawal is that you are still subject to yearly contribution limits, which means it may not be possible to top up your account in the future.
Benefits are Tax-Free
Anyone who inherits your Roth IRA must accept the required minimum distributions; however, they get some benefits. Specifically, if the Roth IRA account is at least five years old, their required minimum distributions won’t be subjected to Federal taxes. Those interested in opening a Roth IRA or rolling a different saving account into a Mega Backdoor Roth IRA should speak with a qualified financial advisor.
Allen Mueller, CFA, MBA of 7 Saturdays Financial point out,
“The biggest benefit of a Roth IRA over the long-term is tax-free generational wealth transfer. When a Roth IRA owner dies, the account is inherited by the named beneficiary with zero tax liability. This is a massive benefit, because typically people inherit assets in their 50’s or 60’s during their peak earning years. By contrast, inherited traditional IRA’s (post-SECURE Act) need to be withdrawn within 10 years and that income is stacked on top of the beneficiary’s existing income. The traditional IRA withdrawals would typically be taxed at a high rate, but the Roth IRA withdrawals are 100% tax free.”
You May Qualify for a Backdoor Roth IRA
We mentioned a Mega Backdoor Roth IRA above, and you may be wondering what that is. Unfortunately, only some people are eligible for a Roth IRA; if your income is too high, you typically won’t be able to use a Roth IRA account. All hope is not lost, however. This is because you can use a back door method to create a Roth IRA that will boost your retirement savings more than you can imagine.
A licensed financial advisor is best suited to explaining the details of a back door strategy, so make sure to visit one before using this method. To use a back door strategy, non-tax deductible contributions would be made directly into a regular IRA account. These accounts are not income limited, which means that no matter how much you make, you can put some away for a rainy day. Then, after building a sizable nest egg, you can use a Roth conversion to roll over your traditional IRA into a Roth IRA.
Growing Your Nest Egg for A Secure Future
Working hard for most of your life should pay for more than just your current lifestyle. In fact, with significant investments and some early savings choices, you can prepare a healthy nest egg that will give you a secure future. A Roth IRA is one of the many tools to help fund your lifestyle following retirement.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.