When Roth IRAs started in 1998, they seemed almost unbelievable. Finally, a tax-advantaged plan that would change the way people think about saving for retirement. This was an entirely new concept, much different from a traditional IRA or 401k, the most common types of retirement accounts before the Roth appeared on the scene. 

While you may still want other investments to draw upon during retirement, a Roth IRA can be an essential piece to the retirement puzzle. Yet, there is still much confusion about what a Roth IRA offers and why it is such a good investment. Here is a primer on Roth IRAs, how they work, and the many Roth IRA benefits.

What is a Roth IRA?

A Roth IRA is a type of individual retirement account or IRA. When you start saving for your post-work years, you can open a retirement account. It could be a 401k or an IRA, or it could be any of several other retirement savings accounts. The main purpose of any of these accounts is that you will be able to live comfortably after you retire or begin to work less.

While many types of retirement accounts can help you save, the Roth IRA offers tax advantages that you will see when you begin to take money out of the account. Even before that, your money can grow, and you will not need to pay taxes on its growth. Roth IRAs have some complex rules. However, most of the rules give you an advantage over other types of plans. 

How Does a Roth IRA Work?

You can open a Roth IRA at any time. By federal law, you need no minimum amount to start a Roth IRA. Therefore, you do not have to wait until you have a large sum to start or contribute to a Roth IRA. However, state or local regulations may require you to begin with a certain amount.

After the Roth IRA is open, you can make contributions with after-tax dollars whenever you like. These Roth IRA contributions can come from periodic contributions, such as if you send some money out of each paycheck. Your spouse could also contribute. You could transfer money from your other sources or take rollover contributions. 

You cannot contribute more than a set amount, as of 2022, $6,000 per year or $7,000 per year if you are already over 50 years old. One thing to note, though, is that everything you put into a Roth IRA must be earned income.

Through your Roth IRA, you have a wide range of options to invest in, such as:

  • Stocks
  • Bonds
  • Mutual funds
  • Exchange-traded funds
  • Certificates of deposit (CD)
  • Money market funds
  • Cryptocurrency

As for withdrawals, you can take money out of a Roth IRA when you choose to do it. This makes the Roth a convenient source of funds if you have an emergency. Also, because no minimum withdrawals are required, you have the option to withdraw at the best time for you, in case you want to wait until the economic factors are in your favor.

There are limits to how much you can contribute to a Roth IRA. For a single tax filer, you can contribute up to $6,000 per year. If you are over age 50, you can contribute up to $7,000 per year. 

In addition, a Roth IRA benefits you by allowing you to make Roth IRA contributions in the amount and at the time you choose. Suppose you receive a windfall, such as an unexpected inheritance. In that case, you can put as much as you like into your Roth IRA as long as you do not exceed the contribution cap. 

What is the Difference Between a Roth IRA and a Traditional IRA?

A Roth IRA is a specific kind of IRA. What differentiates it from a traditional IRA is that you put after-tax dollars into the account. Since conventional individual retirement accounts only accept pre-tax dollars, you must pay taxes whenever you withdraw money from them. 

However, the difference between a Roth IRA vs. a 401k or a traditional IRA is that, with a Roth IRA, you have already paid the taxes, so you do not have to pay taxes when you withdraw. That means when you reach retirement age and possibly have a finite amount of money to live on, you will have more money that you don’t have to share with the IRS.

In addition, traditional IRAs require you to take minimum distributions at age 72. The Roth IRA does not have such a requirement. In fact, you can withdraw money from a Roth IRA before or after retirement in the amounts you choose.

The Benefits of a Roth IRA

Because of the many Roth IRA benefits, they have become quite popular. You can see that putting your after-tax dollars into this type of retirement account makes a huge difference. Here’s why it matters and more about the Roth IRA benefits.

Tax-Free Retirement Income

What goes into a Roth IRA? You can make various types of contributions as long as the tax has already been taken out. Then, when you take distributions, you receive tax-free income. So, you pay the taxes before you make the contributions. That means the tax is already paid, and you don’t have to pay it again when you take the money out. 

One advantage is that you do not have to give anything to the IRS when you withdraw. However, there is another benefit here. Your money can grow as long as it is in the IRA, and you do not have to pay taxes on those gains, either.

Use Your Contributions at Any Time

In a traditional IRA or 401k, you may only take out your contributions after retirement. However, another of the benefits of a Roth IRA is that you can take distributions at any time. Therefore, if you have an emergency before retirement, you can use your contributions at that time without any penalties.

Better Terms For Heirs

One of the major complaints about leaving assets to your heirs is that the IRS takes a significant portion of it. However, the Roth IRA is different. You have already paid the taxes, so your heirs do not have to pay them out of their inheritance. In most cases, your heirs receive tax-free money to use as they please. Then, if you do not need the money while you are alive, you know that it will likely all go to the people you designate. 

It’s important to remember that retirement savings plans are complex. Before you assume that your heirs will get tax-free money, talk to an estate planning attorney. They will guide you on the best ways of setting up your estate in the way you choose.

Almost Anyone Can Contribute

Other types of retirement accounts are not open to anyone. For example, a 401k is usually offered by an employer, and individuals usually can’t start one. You can only open a traditional IRA if you are under 70½ years old, even if you still have earned income. However, nearly anyone can open a Roth IRA. 

Not everyone can have a Roth IRA, but most people can. Only a few restrictions prevent some people from having a tax-advantaged Roth IRA. First, you have to have earned income, which is what goes into a Roth IRA. 

If you make over a specific amount, you do not qualify to open a Roth IRA. As of 2022, you could not start a Roth IRA if your taxable income amounted to $140,000 or more as an individual tax filer or $208,000 or more if filing taxes jointly with your spouse.

No Required Minimum For Distribution

Traditional IRAs force you to take a required minimum distribution starting at age 72. If you do not do so, the penalty is a 50% excise tax on the money you leave in the IRA. The Roth IRA has no such minimum distributions. You can take what you want when you want. Or, you can leave the money in the account for as long as you have earned income yearly.

Another of the Roth IRA benefits is that you can choose to take distributions at the time you see fit. Thus, if the economic climate and the market are unfavorable, you can wait for another better time to withdraw money from a Roth IRA. 

Should You Open a Roth IRA?

Opening any retirement savings plan takes some thought and consideration. The same is true of a Roth IRA. It is critical that you speak to a professional, ask questions, and think about what you want from such a plan. Also, consider your own situation and plans for the future.

You may want to open a Roth IRA if you:

  • Have taxable income that doesn’t exceed the maximum allowed
  • Want your heirs to receive everything in your retirement account and not inherit your tax obligation
  • Want to be able to take distributions whenever you choose
  • Expect tax rates to rise by the time you take distributions, so you want to contribute already taxed dollars now rather than pay more than you would after taxes rise
  • Have many years to go before retirement as you watch your investment grow
  • Are over 50, still earning money, and plan to continue working
  • Expect your income to rise over the years
  • Want to choose how much you take. With a Roth IRA, there are no minimum distributions
  • Want your investments to grow without accumulating a tax burden
  • Are self-employed or in a pass-through business, so no employer contributes to your retirement account

However, even if you do not fall into any of these categories, you might still want to open this type of account. It could be your primary retirement account, or it could be in addition to what your employer offers you. Either way, the Roth IRA benefits are so numerous that nearly anyone who qualifies could find a reason to invest in one. 

Closing Thoughts

The more you know about retirement account options, the better prepared you will be to choose the right accounts for you. Still, it makes sense to talk to someone who deals with retirement accounts frequently. 

In the end, all the Roth IRA benefits add up to an excellent choice for almost anyone. If you meet the requirements to open this retirement savings account, consider putting as much as possible into it. 

The money you contribute and the gains you make from it over the long term will nearly always be accessible to you when you need it. However, what you do leave in a Roth IRA will continue to grow, tax-free, until a later time. A Roth IRA is well worth exploring and considering for most people who meet the earnings requirements.

In addition, remember even with the Roth IRA benefits, you may still want to have more than one retirement account to draw on at retirement. In that case, you can have a Roth IRA as well as whatever other investments you are offered by your employer or hear about from your financial advisor. There may be limits on what you can put into these plans, so you will have to do your due diligence to ensure you make the right choices.

Ultimately, only you can decide whether to open and contribute to a Roth IRA. Even if you have any questions, you can get the answers from someone with expertise in the subject.

If you plan well and contribute what you plan to, you could have more money when you get to retirement. So, get some professional advice and see if it makes sense in your unique situation. It might be one of the most financially sound decisions you have ever made.

Would you like to explore more financial resources and tools for planning your retirement? Check out our best resources here. 

About the Author Tiffany Aliche

Tiffany “The Budgetnista” Aliche, is an award-winning teacher of financial education, America’s favorite, personal financial educator, and author of the New York Times Bestselling book, Get Good with Money. The Budgetnista is also an Amazon #1 bestselling author of The One Week Budget and the Live Richer Challenge series and most recently, a children's book, Happy Birthday Mali More.

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