There is a serious retirement crisis in America. Too many people have little to no savings and aren’t doing anything to help their situation.
45% of Americans have saved nothing for retirement, including 40% of Baby Boomers. 38% don’t actively save for retirement at all. 20% of Americans dip into their 401k accounts early.
The good news is that you can change your situation and that is why we are continuing our discussion of different retirement vehicles and how they can help you on your journey to save for retirement.
Next up we will look at what a Roth IRA is and how it can be of benefit to you.
What is a Roth IRA?
A Roth IRA is a special retirement account where all the taxes are paid up front and then all future withdrawals are free. This differs from the Traditional IRA which defers all the tax consequences until a later time.
There are no upfront tax deductions like there is with a Traditional IRA. The great thing about the Roth IRA is that there are no penalties for distributions from monies that are contributed.
What this means is that any monies you contribute are tax-free at any time during its time in a Roth IRA. You would be responsible for any taxes due on the earnings or dividends paid .
In other words, any money that is earned would be taxed but not the original contribution.
This is the perfect vehicle for the younger, lower income that won’t miss the upfront deductions and can benefit from the decades of tax-free compounded growth.
You can contribute to a Roth IRA as long as you have earned income. You can be a rocket scientist or a greeter at Walmart, as long as you have earned income you can have a Roth.
Qualifications for a Roth IRA
Can contribute if your monthly gross income(MAGI) is less than $164,000 and you are single or filing single head of household.
Can contribute if you are married and file jointly and your income is less than $183,000.
You can make a partial contribution if your Roth if you file single and your income is between $116,000 and $131,000.
Or if you are married filing jointly. You can contribute if your income is between $183,000 and $193,000.
You are not able to contribute if your income is above any of the previous levels, based on your filing status.
Special rules apply to married couples who live together at any time during the year but who file separate returns. Neither can contribute to a Roth if their income exceeds $10,000.
Let’s move on to the benefits.
First Benefit: Flexible enough that you can withdraw the monies at any time tax-free and penalty-free.
Second Benefit: No mandatory withdrawals. Roth account holders are never required to take money out of their accounts, unlike the Traditional IRA which requires mandatory withdrawals. How does this help? This is extremely helpful in estate planning as it allows the balances to continue to grow.
Third Benefit: You normally must hold the Roth for 5 years or until 59 ½ before you can withdraw the earnings tax-free or penalty-free, but there are exceptions:
- Disability of account holder
- Using up to $10,000 for the purchase of first time home buyer for yourself or certain family members
- You can also avoid 10% early withdrawal penalty, but still have to pay taxes if you withdraw to pay for higher education costs for yourself or a family member
Fourth Benefit: Heirs pay no income taxes on inherited Roth IRAs but they are required to take distributions throughout their lifetimes.
Fifth Benefit: Saving during retirement. You can continue to make contributions during retirement while you are working as long as you stay in the income requirements. Traditional IRAs do not allow contributions after 70 ½.
Sixth Benefit: Missed out making a contribution during the year. No worries because you can contribute to the previous year’s taxes up until the current year’s filing date. April 15th or thereabouts.
Seventh Benefit: Roth IRA income requirements are not affected by an employer’s retirement plan. Those limits only apply to a tax-deductible contribution to a Traditional IRA.
Eighth Benefit: Once you max out your 401k contributions you can make contributions to a Roth IRA. This allows you to continue to grow your savings after you have met your limits on the 401k. This also allows continuing to have monies that are tax-deferred.
Ninth Benefit: Investment flexibility. A Roth IRA allows you the flexibility to invest any way that you like. Unlike your Roth in a 401k, you have the ability to buy individual stocks, mutual funds, EFTs, bonds, etc.
Typically a 401k will have limited options to choose from which can limit your ability to earn more money.
Tenth Benefit: Great vehicle for rollovers from 401ks. When you leave your job for greener pastures you have the ability to take that money with you.
This is called a rollover which allows you to withdraw the money from your 401k without penalty. The trick is to roll it over to a Roth or Traditional IRA. Which helps you avoid the penalties and fees as wells as giving you the flexibility to invest in whatever you wish.
I strongly encourage you to do this as soon as you leave a company for a couple of reasons. First, so you don’t forget it! Secondly, some companies charge a fee to manage it for you if you are not still employed with them.
To sum up the Roth IRA we need to remember how it functions and what some of the benefits are.
One of the most important features of the Roth IRA is that it is a tax-deferred account.
Meaning that when you contribute to a Roth IRA you have already paid taxes on the monies being put into the account. And during the time those monies are growing you will never pay taxes on those original monies. You would only pay taxes on withdrawals of capital gains or earnings.
It is a great account for young, lower-income earners as it can help them have their contributions grow tax-free during their lifetime, allowing the power of compounding to do its magic.
There are some income restrictions to keep in mind but always consult with someone before opening a Roth IRA.
To help with deciding whether or not a Roth would be a good fit for you I will include this great link to an awesome Roth IRA calculator
As always I want to thank you for taking the time to read this post.
Do you have any questions about Roth IRAs? Let me know in the comments!