Roth IRAs: What You Need to Know

Feb 12, 2020 10:00:00 AM

It’s never too early to start thinking about retirement. The savings you build early in life can have a big impact on your financial wellness later in life; and the earlier you start saving and investing, the better chance you’ll have to retire on your own terms and enjoy a financially comfortable post-professional life.

Roth IRAs are one of the most important options to understand if you’re looking to start building up your retirement savings. You’ve probably heard the term Roth IRA – but what exactly does it mean, how does it differ from other retirement savings options, and why should you care?

Read on for an easy-to-understand snapshot of everything you need to know about Roth IRAs.

IRA stands for “individual retirement account”

A traditional IRA is a savings account where you can leave your money and let it earn interest. Your IRA might include stocks, bonds and mutual funds; but unlike a traditional investment account, you won’t pay any taxes on account contributions or earned interest until you retire, or meet other criteria. This is a fantastic benefit, which the government offers as a means of encouraging people to save and invest for retirement.

A Roth IRA also offers special tax benefits, but in a slightly different way

A Roth IRA is funded with net earnings, or money that’s already been taxed, so you don’t get your tax benefit up front as with a traditional IRA. Instead, the tax advantage comes after retirement, when you’re able to make tax-free withdrawals from the account; assuming certain criteria are met. These criteria include being at least 59½ years old, and having contributed to the Roth IRA for at least five years.

Which kind of IRA is better will depend on your individual situation

Because a Roth IRA offers a tax-free source of income in retirement, this can be a good choice for people who are able to pay taxes on their income now in order to get tax-free access to a nest egg later on. On the other hand, investors who are working to pay off debt at the moment, or may be looking to reduce their current tax liability, might appreciate a traditional IRA account to enjoy tax deductible account contributions right now. Roth IRA has income and contribution limits depending on your earnings and age. The IRS website provides detailed information to help you determine your contribution limits.

Roth IRAs also offer the benefit of being able to withdraw contributions at any time; whereas with a traditional IRA, withdrawing any money – earnings or contributions – before the age of 59½ will trigger a 10% penalty.

There are some exceptions when you can withdraw earnings early, and not pay a penalty. You can withdraw up to $10,000 of earnings penalty-free to help make a first-time home purchase, or to pay for college expenses without paying the additional 10% penalty, although income taxes will apply to the earnings.

Another feature of the Roth IRA is the ability to contribute no matter your age, unlike most traditional retirement accounts that limit your contribution abilities. Having a Roth IRA means you can continue to add funds to the account and create an even larger sum for tax-free withdrawals later on.
So now that you know a few key features and benefits of having a Roth IRA for your retirement savings, it’s time to address the biggest question of all – who should have one?

Who Should Start a Roth IRA?

Don’t let the idea of a “retirement” account fool you into thinking that Roth IRAs are only appropriate for older adults. In fact, younger people in a lower tax bracket can benefit greatly from starting a Roth IRA while they’re young – paying a small amount of tax now, on money that will potentially earn interest over time and offer tax-free income later in life. And of course, when it comes to any kind of savings or retirement planning, the earlier you start the better set you’ll be to enjoy a more comfortable retirement.

Roth IRAs may also a good choice for anyone who is self-employed. You’ll want to investigate your options to ensure you’re taking the right steps today to be ready for a happy and financially healthy retirement in the future.

Even if you do have the traditional 401(k) retirement savings account, there may be benefits to holding a Roth IRA. With both a 401(k) and a Roth IRA, you will enjoy two levels of tax advantage – one in the short-term, on contributions into the 401(k), and one in the long-term, on eventual withdrawals from the Roth IRA. A 401(k) offers the potential benefit of obtaining matching contributions from your employer, so you’re not just stashing away a percentage of your paycheck, but actually getting more bang for every buck you save. Add onto this the later-in-life tax benefits of a Roth IRA, and you’re making good progress on the road to financial security in the future.

With a baseline understanding of the Roth IRA, it’s time to get saving! What’s your plan for retirement? If you’d like to learn more about saving money for retirement, click here. Happy saving!

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Tags: Savings, Money Tips, Retirement