If there’s one retirement account that nearly everyone should consider making part of their nest egg, it’s a Roth IRA.
Since their invention, Roth IRAs have been hailed by financial gurus and retirement planners alike as one of the best deals you can get. This is not only because of the unique and creative way that the taxes are handled but also because a Roth IRA can offer you many other advantages that you simply won’t get with other retirement tools.
In this post, I’d like to highlight five important reasons why you should start contributing to a Roth IRA starting right now.
1. Tax-Free Income
By design, the most lucrative feature of a Roth IRA is tax-free retirement income. After you reach age 59-1/2, all of the withdrawals you pull from it won’t be counted as taxable income. This is because you’ve already paid taxes on that money in the year that you contributed.
That’s a huge advantage over other types of retirement plans such as a 401k and traditional IRA. With those plans, the IRS lets you defer your taxes until you retire and start making withdrawals. That’s good in the present, but it can mean significant tax payments in the future – especially if tax rates happen to go up!
That’s a major distinction. Once you’re retired, the last thing you’re going to want to do is to give tens of thousands of dollars of your income over to the IRS. Chances are that things like healthcare and other necessities will have gone up in price anyways due to inflation. Therefore, the more you can keep for yourself, the better off you’ll be.
2. Tax-Free Growth
Typically when you invest your money and earn gains, you have to eventually pay taxes on them. But that’s not the case with a Roth IRA. Because your account is funded with after-tax dollars, all of the gains you earn from investments inside your Roth will be available to you tax-free after age 59-1/2.
On the surface, that might not sound like a big deal. However, depending on what you invest in and how well it does, this could work out to your benefit in an incredible way.
To illustrate one extreme case, take Peter Thiel, one of the founders of PayPal. In 1999, Thiel invested $2,000 worth of stocks in his Roth IRA. As of today, those investments are now worth over $5 billion! And yes – technically that’s all tax-free money!
3. Lower Social Security Taxes
Social Security benefits are something everyone is entitled to as long as they’ve ever paid FICA taxes and earned enough credits to qualify. However, something that not a lot of people know is that you may also be eligible to receive them tax-free.
This is determined by your tax filing status and something called “provisional income” which is basically your taxable income when you’re retired. The more provisional income you have, the higher your chances that you’ll have to pay taxes on up to 85 percent of your Social Security benefits. However, if your provisional income is low enough, then you might pay taxes on only 50 percent or none at all.
So how do you get the money you need for retirement but have it not count towards your provisional income? By using Roth IRA withdrawals. Since the money in your Roth is available to you tax-free after age 59-1/2, it doesn’t count towards the IRS provisional income calculation. In other words, not only will your withdrawals be tax-free, but they can also help make your Social Security benefits tax-free too.
4. No RMDS
Age 72 might seem like a long way away for some people. But something you’ll want to keep in the back of your mind is that when you reach this age, the IRS will literally start forcing you to take money out of your retirement plans.
These are called RMDs or required minimum distributions. It’s the IRS’s way of finally collecting the taxes you owe them. Remember that the money you saved to your 401k and traditional IRA is all tax-deferred. The government doesn’t want to wait forever, and so this is why they’ll start imposing RMDs once you get to a certain age. And if you neglect to make them, there’s a hefty 50 percent penalty for failing to do so.
Fortunately, with Roth IRAs, there are no RMDs. Again, this is because you’ve already paid taxes on your contributions. Since the IRS isn’t going to tax you twice, you’re all good. That means you’re free to manage your withdrawals however you like.
5. Emergency Funds When You Need Them
I wouldn’t normally suggest taking money out of your retirement accounts prematurely. But hey … sometimes life happens, and you need money fast!
What if an emergency came up such as:
- A job loss?
- A major house or vehicle repair?
- An unplanned medical procedure?
For a lot of people, they might end up racking up a lot of high-interest credit card debt, or, worse, take out some kind of scammy personal loan. This is where a Roth IRA can save you.
According to the IRS, you’re allowed to withdraw your contributions anytime you want since you’ve already paid taxes on them.
Just be careful not to also withdraw any of the earnings portions of your investment (the part that grew on top of your contributions). Those cannot be withdrawn until age 59-1/2, or it would trigger a 10 percent penalty plus income taxes.
Save More for Retirement
There are so many other great reasons to use a Roth IRA as well as other retirement accounts. To contribute more, you’ll want to free up as much money from your budget as possible. A budgeting app like Buxfer can help you to do this.
Buxfer connects with your banks and credit cards and organizes all of your transactions by category. This helps you to easily pinpoint where you might be spending too much and where some improvements could be made. The less income you need for your expenses, the more you’ll have to contribute to your Roth IRA.
Image credit: Pexels