Retirement: you hear about it, you might read about it, and perhaps even save a little for it…but it seems so far off in the future, doesn’t it? As nice as it would be, your income stream isn’t endless and eventually you will need to save enough to last through your later years.
It’s important to save for retirement, but you may not be utilizing an important tool in your retirement plan: a Roth IRA. Roth IRAs are not as popular as their more well-known counter part, the Traditional IRA, but that does not mean they are not as equally as important.
What is a Roth IRA?
A Roth IRA is a post-tax retirement account that is funded with income-based contributions. These contributions can then be invested in a number of ways (Stocks, Bonds, ETFs…) just like a Traditional IRA.
Why is a Roth IRA Important?
The key to its importance is based on the fact that it is a post-tax retirement account. This means that you are not taxed on withdrawals, which is a major difference from a Traditional IRA. A Traditional IRA, on the other hand, is taxed on withdrawals and penalized on early withdrawals.
Because you aren’t taxed on a Roth IRA, you know exactly the amount you will receive when you withdraw your funds.
Main Benefits
There are a lot of benefits to having a Roth IRA, but here are some of the more notable benefits:
Tax Free Growth
The greatest benefit by far is that this is a tax-free growth account, meaning you never pay taxes on withdrawals. There is a penalty for early withdrawal of gains, not contributions.
Nerd Wallet has a Roth IRA Calculator that allows you to visualize the benefits of this type of retirement account. When I filled this out, it shows I would have saved about $200,000 in taxes when compared to a similar taxable investment account. Tax savings…yes please!
No Required Minimum Distributions
IRA accounts have something called “required minimum distributions” (RMD). RMDs force owners to start withdrawing a minimum amount from the account once they have reached the age of 70 ½ .
This rule does not apply to Roth IRAs because the money is yours and it has already been taxed. This means that in retirement you can withdraw any amount at any time without penalty. This allows for flexibility of usage in your retirement.
Better Planned Retirement
As you get older and start reaching that retirement age, you want to be able to plan for what your life will look like. A key part of that is knowing what your monthly income will be since you will no longer be working. That is why I love the Roth IRA. It is your money, free from the government’s greased palm.
You know how much money you have access to and therefore you can plan how best to use it over the life of your retirement.
Conclusion
Roth IRA accounts are not the end-all-be-all in retirement accounts, but they provide unique benefits over other retirement accounts. A Roth IRA is an important part of your investment and retirement portfolio and provides a bit of diversification, which is key to your portfolio’s success.
If you would like to know more about Roth IRAs and some of the restrictions click here.
