Building up retirement savings can feel daunting, but you likely know that the sooner you start saving for retirement, the more you’ll be able to put away for your future. And, when it comes to building that savings, you have a lot of options available to you, including a Roth IRA.
What exactly is a Roth IRA, and does opening one make sense for you? In this post, we’ll explain the details, and help you explore the pros and cons to see if this type of retirement savings makes sense for you (or not).
What is a Roth IRA?
The term “Roth IRA” was coined in 1997 after combining names from its founder, and former US Senator, William Roth, and “individual retirement account” (IRA).
With this type of retirement account, individuals build up savings by contributing after-tax dollars. This means there are no current-year tax benefits, and all contributions and earnings grow tax-free. Individuals can also withdraw funds tax- and penalty-free after age 59½ (so long as the account has been open for five years or more).
When does opening a Roth IRA make sense?
One of the biggest considerations in opening a Roth IRA is your age. As Bankrate explains, the longer you have between now and retirement, the more that the prospect of compounded tax-free growth in a Roth IRA stands out as a big differentiator.
Because funds grow tax-free and withdrawals come tax and penalty-free, opening a Roth IRA can be a good option for individuals saving for retirement who expect to be in a higher tax bracket in the future.
Along with being tax-free, Roth IRA’s, unlike traditional IRAs, are RMD-free, meaning there is no required minimum distribution. This means, unlike traditional IRA account holders – who are required to start withdrawing from their accounts at age 72 to avoid a 50% penalty excise tax on the amounts not withdrawn – Roth IRA account holders are free to let all of their money stay put for as long as they’re alive. This fosters tax-free investment growth for as long as you’d like, meaning the earlier you start saving, the bigger your savings will be.
What should savers be aware of?
Although there are clear benefits, like every financial decision, a Roth IRA might not be the best move for everyone. To start, Roth IRAs don’t allow withdrawals until at least 5 years after opening up the account. This means if you think you’ll need access to your savings sooner, you may want to consider another type of savings account. It’s also worth noting that, since Roth IRA contributions are made after taxes, savers won’t get any immediate tax gratification from a Roth IRA.
Additionally, there are income limits to a Roth IRA that savers should be aware of. As Investopedia explains, “the limits are based on each individual’s modified adjusted gross income (MAGI) and tax filing status. In general, you can contribute the full amount if your MAGI is below a certain amount. You can make a partial contribution if your MAGI is in the “phase-out” range. And if your MAGI is too high, you can’t contribute at all.”
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