Top 10 Roth IRA Benefits
Individual retirement accounts changed forever when new legislation in 1998 created the Roth IRA. A Roth IRA is nearly identical to a traditional IRA, with a few very important tax changes. Rather than being funded with pre-tax money, like a traditional IRA, a Roth IRA is funded with after-tax money. Distributions are also handled differently — and more favorably — for Roth IRAs. But Roth IRAs also come with certain income restrictions that don’t apply to traditional IRAs. Here’s an overview of the general characteristics of Roth IRAs, along with a specific look at their top 10 benefits.
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1. Tax-Free Growth
Money you have in a Roth IRA grows tax-free. Unlike in a regular, taxable investment account, any income or capital gains you earn in a Roth IRA are never taxable. This means the account can grow more rapidly, as you don’t have to tax money out of it to pay taxes every year.
2. Tax-Free Withdrawals
When you take a “qualified distribution” from a Roth IRA, you won’t have to pay tax on any portion of it, neither your contributions nor your earnings. This is in direct contrast to withdrawals from a traditional IRA or 401(k) plan, where both earnings and contributions are fully taxable when you take them out.
3. No Required Minimum Distributions
Most traditional retirement plans, like IRAs and 401(k) plans, require account holders to take annual distributions upon reaching age 73. But Roth IRAs have no such stipulation. You can leave your money in your Roth IRA your entire life if you would like to, no matter how long you live. Since the government is not getting any tax revenue from Roth withdrawals, it has no reason to require account holders to take distributions.
4. No Taxes or Penalties for Withdrawing Contributions
One of the key benefits of a Roth IRA is that you can always take back your contributions without paying any taxes or penalties. Since that money has already been taxed before it is contributed to a Roth IRA, it can’t be taxed again if you take it out.
5. Investment Freedom
In terms of investment options, a Roth IRA is like a regular, taxable account. You can buy stocks, bonds, mutual funds, ETFs or any other type of security offered by your brokerage. This makes it less restrictive than some 401(k) plans, which only offer a select menu of mutual funds, for example.
6. Protection From Long-Term Tax Hikes in Tax Rates
If tax rates are higher by the time you retire, the money in your pre-tax retirement accounts, like your traditional IRA or 401(k) plan, become less valuable. This is because you’ll lose more of your account balance to the tax man. But if you have a Roth IRA, it won’t matter what tax rates are by the time you retire, because any money you withdraw will be tax-free.
7. Shielding From Medicare Surtax
High-income taxpayers face a 0.9% Medicare surtax, but Roth distributions aren’t considered income for purposes of this calculator. For this reason, it might be better if you’re a high-income taxpayer to take withdrawals from a Roth instead of another type of retirement plan.
8. Doesn’t Prevent You From Contributing to 401k Plan
There’s no IRS rule preventing you from contributing to both a Roth IRA and a 401(k) plan. The only limitations are the ones that apply to both types of accounts, such as the income limitations on contributing to a Roth IRA and the fact that you need earned income to contribute.
9. Never Have To Stop Contributions
Prior to 2020, you couldn’t continue contributing your traditional IRA after age 70 ½, as that was when minimum distributions were required to begin. That gave Roth IRAs a big advantage, as there was never an age limit on contributions due to the fact that there are no required minimum distributions. The law change in 2020 has put these two accounts back on equal footing. However, as laws can change again, Roth IRAs still have an implied advantage as there’s no reason for them to ever have this type of contribution restriction.
10. Money Flows Tax-Free to Heirs
Although there are rules involved in inheriting an IRA, your heirs will most likely benefit from tax-free distributions from your Roth IRA.
11. Expert Insights
Most financial experts and commentators feel that a Roth IRA is a good option for investors, particularly for younger ones. Dave Ramsey, for example, says “While a Roth IRA doesn’t offer any current-year tax benefits like a traditional IRA, it gives you something even better: tax-free growth and tax-free withdrawals once you retire. Now, that’s a sweet deal!”
Jaspreet Singh, another financial personality, also endorses the Roth IRA, saying it helps to avoid the uncertainty of future tax rates. Suze Orman is also onboard with Roth accounts, saying “I think it’s smart to save in a Roth IRA because when you retire, all your withdrawals will be 100% tax-free.”
Anecdotally, it’s worth noting that one of the world’s most famous investors, the “Oracle of Omaha” Warren Buffett, has reportedly got tens of millions of dollars in a Roth IRA, which seems to be an endorsement of the account.
12. Steps To Open an Account
You can open a Roth IRA at nearly any place that you can open a regular taxable account, including banks, credit unions and brokerage firms. Whichever option is the most convenient for you that also makes financial sense is the best place for you to open one. For example, if you have an existing relationship with a broker, it might be easy to keep all your money in one place. On the other hand, if you find a firm that offers a no-fee Roth IRA with additional bells and whistles, you might consider that as well.
To actually open a Roth IRA, you’ll need the same type of information as opening any other type of brokerage account. For example, you’ll have to provide personal and financial information such as your name, address, date of birth and Social Security number.
FAQ
What are the three major benefits of a Roth IRA?
The three major benefits of a Roth IRA are that your earnings grow tax-free, your distributions are tax-free and you can withdraw your contributions at any time without paying taxes or a penalty.
What is a disadvantage to a Roth IRA?
The main disadvantage of a Roth IRA is that you won't get a tax deduction on your contributions. However, this is usually more than made up for by the fact that you can take qualified tax-free withdrawals.
Another disadvantage is that your income has to be below certain levels in order to be eligible to open a Roth IRA. For 2024, eligibility phases out from $146,000 to $161,000 for single people, and $230,000 to $240,000 for joint filers.
Is a Roth IRA better than a 401(k)?
A Roth IRA generally allows you more investment freedom, as you can purchase nearly any type of security you want. It also doesn't have any required minimum distributions. However, a 401(k) has a higher contribution limit, no income restrictions on contributions and the opportunity to snag an employer match.
How much will a Roth IRA grow in 10 years?
The longer you can stay invested in a Roth IRA, the more you can take advantage of tax-free compounding. Your actual return, however, will depend on your investment success. If you can earn a 7% return on your investments, for example, your money will roughly double in 10 years. But if you contribute the maximum of $7,000 every year for 10 years and earn a 10% return on that money, you'll end up with closer to $119,000.
At what age does a Roth IRA not make sense?
If you're at your peak earnings level late in your career, you might prefer the benefits of a traditional IRA over a Roth IRA. If you can snag a big tax deduction on your contributions and pay a lower tax rate once you retire, the structure of the traditional IRA may make more sense.
One thing to note, however, is that you can't withdraw earnings tax-free from a Roth until the account has been open for at least five years. If you're planning on opening an account at age 64, for example, this means you won't have tax-free access to your earnings until age 69.
This article originally appeared on GOBankingRates.com: Top 10 Roth IRA Benefits
