What is a Roth IRA? Does it have any unique benefits? Does it have any withdrawal rules that I should be familiar with? If these are some of the questions that you have been asking yourself in the recent past, then you are in the right place, because in today’s article, I will take you through the basics of Roth IRAs. Let’s hop right into it.
What is a Roth IRA?
A Roth IRA is a type of individual retirement account that allows for your retirement savings to grow tax-free. Roth IRAs are similar to traditional IRAs, with the main difference being the manner in which they’re taxed. You are also required to fund your account using after-tax dollars, and this means that the contributions you make are not tax-deductible. When you start withdrawing your funds, however, they are tax-free.
In contrast, traditional IRA owners usually fund their accounts using pretax dollars, get tax deductions on their contributions, and also pay their income tax upon withdrawing the funds in their IRAs after getting to their retirement years.
How do Roth IRAs work?
With Roth IRAs, an account holder is necessitated to pay taxes on their investment upfront, thus enabling their money to compound so that they can take their withdrawals during their retirement years without having to pay taxes.
This type of IRA is also structured in such a way that you can withdraw the contributions made to your account if you have an emergency, without being taxed or penalized. While this is a benefit that you can take full advantage of, it does not necessarily mean that you turn to your Roth IRA every time you have an emergency. If anything, an IRA should be your long-term investment vehicle.
What are the benefits of an IRA?
Potential benefits of IRAs include:
- Tax savings – by opting to use a Roth IRA as your retirement savings vehicle, you get to pay taxes on the money you contribute now, and not later, when the tax rates are likely to be high. It only makes sense to pay your taxes now, when they’re lower, as you look forward to taking tax-free retirement withdrawals during retirement.
- You can contribute to your Roth IRA as you also contribute to your employer-sponsored 401(k) plan.
- Flexibility – Roth IRA rules allow you to choose when and how much you should contribute to your account. You can, for instance, decide to contribute $6000 at once, at the start of the year, or you can split this amount into several tranches that you can pay several times throughout the year.
- Easy withdrawals – with a Roth IRA, you can withdraw the funds you have contributed without getting penalized or taxed further.
- More time to contribute – all Roth IRA account holders are granted sufficient time (until the tax deadline) to send the required contributions from the previous calendar year.
- No Required Minimum Distributions (RMDs) – Unlike traditional IRAs, Roth IRAs rules do not necessitate an account owner to take RMDs upon hitting 72 years.
- There is no age limit to open a Roth IRA- you can open your Roth IRA at any age, provided you have an earned income.
What Are The Drawbacks of Roth IRAs?
Roth IRAs barely have any major drawbacks that can make one shy away from them, besides the following:
- Unlike most of the other 401(k) plans, Roth IRAs do not allow one to take a loan against them. You can, however, take withdrawals without being penalized, as discussed above.
- The early withdrawal of one’s investment earnings attracts a 10% penalty unless one meets the allowed exceptions.
Which Roth IRA withdrawal rules should I be aware of?
Taking withdrawals and distributions without adhering to the IRS guidelines can lead to a Roth IRA holder walking home with a significantly lower amount of money, due to unnecessary penalties and taxes. Here are the rules that you must uphold:
- You are allowed to withdraw your original contributions from the Roth IRA at any time that you want to, without being taxed or penalized, regardless of the time that your account has been open. This is because the money that goes into your Roth IRA is money for which you have already paid income tax.
- Those who are aged not less than 59 ½ years and have held their accounts for not less than 5 years can withdraw both their contributions and earnings without being taxed or penalized.
- When you decide to take withdrawals from your Roth IRA, the IRS will assume that the original contributions you made to the account will come out first.
- All the qualified withdrawals of the earnings in your Roth IRA can be made tax-free. Failure to meet this withdrawal requirement will lead to taxes and possible penalties.
Are Roth IRAs Insured?
If your Roth IRA is at a bank, then you should be aware that IRAs do not fall into the same insurance categories as the other types of common insurance accounts. Also, the coverage for most IRA is not that robust. The Federal Deposit Insurance Corporation, popularly abbreviated as FDIC, offers insurance protection to the tune of $250,000 for Roth IRAs and traditional IRAs, but the IRA balances are combined, not viewed separately.
For instance, if you as a customer has a CD that is held within your traditional IRA that has a total value of $200,000, and you also have a Roth IRA within your savings account that has a value of $150,000, within the same institution, then you have $100,000 worth of assets that aren’t covered under FDIC coverage.
You have made a wise decision to read this article as it is never a bad thing to keep educating yourself, right? You might also want to read some of the related posts below:
That will be all for today’s post on what a Roth IRA is about. I hope you found this post helpful and educational. Let me know whether you have any questions with regards to what we have discussed here today, as well as how you can open a self-directed account to start investing in assets such as gold and silver.
I wish you well,
Eric, Investor and Team Member at Gold Retired!