Investing in a Roth IRA is a smart choice for many people, as it offers a variety of benefits that can help you save for retirement and beyond. With a Roth IRA, you invest money that has already been taxed at your regular rate and withdraw it with your tax-free earnings when you retire. This means that you don't get a tax cut up front, but your contributions and earnings increase tax-free. Additionally, there are no mandatory minimum distributions (RMD) during your lifetime, making Roth IRAs the ideal wealth transfer vehicles. In some cases, the traditional version of the IRA or 401(k) may have a stronger appeal.
This often depends on how much you earn now and how much you expect to contribute once you stop working. With a traditional or 401(k) IRA, you invest with pre-tax dollars and pay income taxes when you withdraw money in retirement. This means that you will pay taxes both on the original investments and on what they earned. If your income is relatively low, a traditional or 401(k) IRA may allow you to get more contributions to the plan as a saver tax credit than you will save with a Roth. A traditional or 401(k) IRA can result in a lower adjusted gross income (AGI) because your pre-tax contributions are deducted from that figure, while after-tax contributions to a Roth are not.
And if you have a relatively modest income, that lower gross gross income can help you maximize the amount you receive from the saver's tax credit. Another reason to consider investing in a Roth IRA is the access to income now versus potential tax savings in the future. A Roth can take away more income from you in the short term because you are forced to contribute in dollars after taxes. In contrast, with a traditional or 401(k) IRA, the income needed to contribute the same maximum amount to the account would be lower, because the account is based on pre-tax income. The result is that a traditional retirement account increases your financial flexibility and allows you to make the maximum allowable IRA or 401(k) contribution while you have extra money on hand for other purposes before you retire. Yes, if you're married and filing a joint return, your spouse can open their own Roth IRA (a spousal IRA) and fund it separately from your own, even if you don't have any earned income.
The combined income of both spouses is treated the same, even if one spouse generates 100% of the income and the other spouse generates 0%. If you make an early withdrawal from a traditional IRA before age 59 and a half, you are likely to face both an income tax bill and a 10% early withdrawal penalty. There are some exceptions; read more about traditional IRA withdrawals. The Roth IRA also allows you to pass any money from the tax-free account to your heirs. Depending on the circumstances, heirs could grow the tax-free account for years, perhaps decades.
But because that money is in a Roth IRA, any distribution will be tax-free for beneficiaries. When it comes to investing in a Roth IRA, all regular contributions must be made in cash (including checks and money orders); they cannot be in the form of securities or property. While Roth IRAs do not include an employer match, they do allow for a greater diversity of investment options. If you plan to bank with the same institution, check if your Roth IRA includes additional banking products. Among the disadvantages of Roth IRAs is the fact that unlike 401(k) IRAs, they do not include an advance tax exemption. Therefore, a Roth IRA can offer you a lot of flexibility if you are in an emergency and need access to cash. Still, those who hesitate to save for retirement early in their adult life because their bank accounts are dangerously close to zero should be comforted by the way Roth IRAs are designed.
That means Roth IRAs are a perfect vehicle for someone starting out who knows they need to build emergency savings and retirement savings, but can't imagine doing both at the same time. If you are unable to leave the earnings of your contributions in a Roth IRA for a sufficient period of time for five years, you will incur early withdrawal penalties.