Planning for retirement is an essential part of every Americans’ financial goals. One of the best ways to achieve these goals is by utilizing a Roth IRA as part of your plan. In the following, we will talk about the Top 5 Reasons You Need a Roth IRA. A Roth can be a powerful investing tool when used to its fullest potential.
What is a Roth IRA?
A Roth IRA is similar to a traditional IRA in many ways. They each have the same contributions limits – $6,500 if you are under age 50 and $7,500 if you are age 50 or older (for 2023). They each allow you to invest your money in the same types of assets. Finally, you can’t touch retirement money before you reach age 59 1/2, or face a tax penalty.
The Individual Retirement Account (IRA), allows anyone to save money for his or her golden years. The only caveat is that you must have earned income during the year(s) you wish to contribute. There’s no reliance on your place of business to offer a 401(k) or similar plan. For many Americans, the IRA is the only available option to save fore retirement.
The major difference between a Roth and traditional IRA is when you pay taxes. Traditional plans are funded with pretax money. This means you get an upfront tax break on any amount contributed. On the other hand, a Roth IRA is funded with after-tax money. There’s no immediate tax break, however, all qualified distributions are tax-free! This applies to all funds in the account, including any profits or earnings.
Together, with your financial advisor, it’ up to you to decide if a Roth IRA is right for you. Here we’ll list the best reasons to open and fund a Roth!
Top 5 Reasons Why You Need a Roth IRA
1. Tax-Free Retirement
As we just talked about, distributions from a Roth IRA are tax-free. Keep in mind that the account must be open for at least five years and you must be age 59 1/2. Otherwise, you won’t receive the full benefits of the plan. These unqualified distributions will be taxed and could face penalties.
This is especially beneficial for when you are in a lower tax bracket early in your career. The upfront tax-break may not be as important as the decades of accumulated (tax-free) savings.
You may have heard that you need to properly diversify your portfolio. Many think that means putting your money into different types of investments, like stocks, bonds and mutual funds. While that’s true, it’s also important to diversify your tax benefits. You know exactly what the tax rate is when you contribute. What you don’t know is what it will be 20, 30, 40+ years from now.
Investing in both traditional and Roth plans is a hedge against future taxes. If you are afraid of much higher rates in the future, it’s best to max out Roth plans. If you’re not too worried about future rates and need a tax break now, lean more towards traditional plans. Additionally, opening a Roth IRA with IRA Financial Trust will allow you to invest in traditional and alternative investments. No longer are you limited to stocks and bonds! Instead, you have the freedom to invest in what you know and understand for a flat fee.
3. Age is Just a Number
It doesn’t matter how old (or young) you are, anyone who earns money can fund a Roth IRA. Obviously, you need a “real” job to open a 401(k), since they are employer-sponsored plans. With an IRA, all you need is earned income. If you are 15 earning money from mowing lawns, you can fund a Roth. On the other hand, if you are 75 and working as a crossing guard, you can also fund a Roth.
Prior to the SECURE Act, you were not allowed to contribute to a traditional plan after you reached the age of 70 1/2. That age was also the RMD start date (see more below). However, as long as you have earned income, you can contribute to either type of plan.
4. No Required Distributions
Once you reach the age of 73, you must begin drawing down the account. This is when you must start taking required minimum distributions (RMD). The taxes on your contributions have been deferred for many years and the IRS wants its cut. These mandatory distributions are determined based on your age and the worth of the plan.
On the other hand, Roth IRAs have no such requirement. You’ve already paid the taxes on your contributions. Because of this, the IRS won’t be knocking on your door. As previously touched upon, your entire Roth IRA can be distributed without any taxes being paid. Therefore, withdrawals won’t be added to your taxable income for the year (unlike traditional withdrawals).
5. Emergency Fund
Last, but not least, is the ability to use your Roth IRA as an emergency fund. Since taxes have already been paid on the contributions, you can withdraw those at anytime and for any reason. You will not be subject to tax or penalty. However, this only is true for contributions. If you withdraw any earnings before age 59 1/2, or if the account is not yet five years old, you will face taxes and penalties.
Here’s an example: You contribute $2,000 to a Roth IRA for three years. In five years time, the account is worth $10,000. If you are under age 59 1/2 at the time, you may only withdraw $6,000 tax- and penalty-free ($2,000 x 3). If you decide to withdraw the entire amount, the $4,000 in earnings will be taxed at current rates.
Bonus Reason to Have a Roth IRA
We’d be remiss if we didn’t mention our most popular plan – the Self-Directed Roth IRA. Not only do you receive all the benefits listed already, but a Self-Directed Roth allows you to invest in virtually anything you can think of.
A Roth IRA opened at a local bank or an online provider like e*Trade are subject to certain limitations. Typically, you are limited to only the investment options they offer. Many financial institutions don’t allow for alternative investments, such as real estate. When you self-direct your Roth IRA with a passive custodian, such as IRA Financial, you are only limited by your imagination.
A true Self-Directed Roth IRA gives you the freedom to invest in what you want, when you want. There are very few things the IRS prohibits investing in, which includes life insurance and most collectibles. By having checkbook control of your Roth IRA funds, you never have to ask your custodian for consent to make an investment. Self-directing has never been easier thanks to the all-new IRA Financial app!
As you can see, a Roth IRA offers several advantages over other retirement plans. Don’t take our word for it – search around, talk to an advisor or friend. The Roth IRA may not be perfect for everyone, but most should find the benefits quite appealing (just ask Mitt Romney).