What are the benefits of Roth IRAs? In the world of individual retirement accounts, investors have a couple of options at their disposal, and it is up to them to weigh the underlying pros and cons to determine the one that is best suited for their financial needs. Today’s post will help you understand what the unique pros of a Roth IRA are, in a bid to help you make a more informed decision as you choose your next retirement investment vehicle.
What is a Roth IRA?
A Roth IRA is essentially a tax-advantaged individual retirement account that you are required to contribute to using after-tax dollars. The primary advantage of this type of IRA is that all your contributions as well as the earnings on those contributions get to grow tax-free until you are hit 59 ½ years, which is the retirement age.
Roth IRAs are quite similar to traditional IRAs, with the only difference being the time at which the two accounts are taxed. We have already established that Roth IRAs are funded using after-tax dollars. Traditional IRAs are, on the other hand, funded with pre-tax dollars – which means that you will pay the taxes on your contributions and earnings on the contributions when you start taking the distributions during your retirement years.
The IRS requires that investors fund their Roth IRAs using earned income. In the present-day world, you can fund your Roth IRA using the following sources:
- Regular contributions from your salary or business income.
- Contributions made on your behalf by your spouse ( also known as spousal contributions)
- IRA transfers
- Through IRA conversions
- Rollover contributions
The contributions must be in cash (e.g. bank checks or money orders), hence you cannot use your securities or property. There is usually an annual limit to the amount of money you can contribute to your Roth IRA, which the IRS decides upon from time to time.
Now that you understand the basics of a Roth IRA, let’s proceed to look at its top benefits.
The Benefits of a Roth IRA
1. Tax-free growth and withdrawals
This retirement investment vehicle’s top benefit is that it gives you the gift of tax-free growth. You can only contribute an amount of money to this type of IRA after it has been taxed, which takes away the worry of having to wait until later to pay the IRS what belongs to them, as you also think about the impact of inflation on your investments. Money in a Roth IRA grows tax-free, allowing you to also withdraw it tax-free when you are 59 ½ years or older.
This in itself makes the Roth IRA structure a powerful instrument to grow their wealth.
2. A reliable way to pass down your money to your heirs tax-free
For those who are in need of a reliable wealth transfer vehicle, then a Roth IRA is worth considering. Roth IRAs allow you to pass your wealth to your heirs and ensure that they will enjoy it without having to pay taxes. Depending on how well-structured your investment portfolio in the Roth IRA is, your heirs could continue growing the assets in the account tax-free for many years, or even decades. The good thing is that since the funds are in the Roth IRA, it does not matter the time at which they will start taking distributions – it will still be tax-free.
Note that there are some rules pertaining to inheritance, and you should understand them well before establishing your estate.
3. You can withdraw your contributions at any time without being penalized
With a Roth IRA, you can take qualified withdrawals at any time, without the IRS penalizing you. This is unlike a traditional IRA, for which you can only take withdrawals of your contributions upon hitting 59 ½ years.
Note that you can only withdraw the amount you contributed to your account at any time and not the earnings on those contributions. For you to withdraw the earnings on your contributions, you have to wait for at least 5 years after opening your account.
A Roth IRA, therefore, offers a lot of flexibility for investors who may need to access some funds when they run into an emergency. While experts will advise you not to touch the money in your Roth IRA, sometimes you barely have other options at hand, and it is a relief to know that you can access your Roth IRA contributions without having to pay more taxes and penalties.
4. No Required Minimum Distributions (RMDs)
Traditional IRAs ( as well as traditional and Roth 401(k)s) have RMD requirements. This requirement forces you to start taking a predetermined distribution from your IRA annually, upon hitting 72 years. With an RMD, unfortunately, account holders are usually forced to withdraw money whether they need it or not. This obviously translates to taxes, and the cessation of the “tax-advantaged compounding element” offered by the IRA.
A Roth IRA avoids the RMDs completely, meaning your funds can continue to grow tax-free long after retiring. This also means that you can pass the retirement account to your heirs, and they will not need to pay any taxes, as already discussed.
5. No age requirements and limits
Unlike other types of investment accounts, opening a Roth IRA does not have any age limits and requirements imposed on the account holders. Provided that you have an earned income from working ( or other allowed sources of income), you can open and contribute to a Roth IRA at any age. In 2022, you can only contribute a maximum of $6000 to your Roth IRA annually, if you are aged below 50. Those above 50 can contribute up to $7000.
A Roth IRA is, as such, a reliable structure that every young individual can take advantage of if they intend to start investing early and maximize their earnings through the power of compounding.
Frequently asked questions on “What are the benefits of Roth IRAs?”
1. Should I open a Roth IRA or a 401(k)?
There are many factors to consider when choosing between these two accounts. Each account presents you with its unique pros and cons, which you need to weigh upon before making your ultimate decision. generally, however, most settle on 401(k) because they have higher contribution limits than Roth IRAs. With Roth IRAs, on the other hand, investors get the opportunity to invest through a tax-advantaged structure in which their investments grow tax-free and in which they are not required to pay taxes when taking withdrawals. Investors can also check out Roth Gold IRAs, which have more benefits, including more control over the account as well as access to a wider variety of alternative assets to invest in.
2. How much can I contribute to my Roth IRA?
In 2022, the maximum amount you can contribute to your Roth IRA annually is $6000, if you are below 50 years. Those aged over 50 can contribute up to $7000 annually. You can decide to deposit about $500 (or $583 if you’re above 50 years) monthly to your account, or you can contribute any amount that you see fit, provided you do not exceed the annual contribution limits.
3. What are the downsides of a Roth IRA?
The main downside of a Roth IRA is perhaps the fact that it does not give you an upfront tax break. Also, in comparison to retirement plans such as 401(k)s, these accounts have significantly lower contribution limits and do not have automatic payroll deductions (this makes it hard to stick to the saving discipline).
4. How can I protect my Roth IRA against a stock market crash?
One of the best approaches to safeguarding your investment portfolio from a stock market crash is diversification. You can decide to invest in assets that have a negative correlation with the stock market so that when the stock market is crashing, the other assets in your portfolio are doing great or simply holding their value. You can for instance do a gold IRA rollover, in which a portion of your funds can end up being tied to precious metals such as gold.
That will be all for today’s post on what the benefits of Roth IRAs are. I hope you found it informative and that you are better placed to decide whether this account is for you or not. Let me know if you have any questions about Roth IRAs or anything in this post.
I wish you well,
Eric, Investor and Team Member at Gold Retired.