Why Is Everyone Obsessed With the Roth IRA
How nice would it be to not work for life? It’s never too early (or late, for that matter) to think about saving for retirement. In fact, the earlier you start, the sooner you can retire (or the richer you will become when you finally retire). The Roth IRA is one of the best investment offers out there, and if you qualify, you should definitely have one.
You’ve probably heard of Roth IRAs (Individual Retirement Accounts) before – especially because financial experts seem to be obsessed with it. And for good reason – it’s a great deal if you start saving early.
Please note that the Roth IRA is different from the traditional IRA. We’ve covered the different types of IRAs here , but the most common options are Traditional and Roth. The differences between the two can be a little tricky , but they basically boil down to this:
- A traditional IRA is not taxable . You can deduct the money that you save on it each year from your income, which means that now you will not pay as much income tax. However, when the time comes to withdraw money for retirement, then you will pay taxes.
- The Roth IRA offers tax-free growth . You can’t deduct your savings from your income like you would with a traditional IRA, but when you withdraw money at retirement, you don’t have to pay taxes — you’ve already paid.
This tax-free growth is one of the reasons many experts and individual investors are thrilled with Roth, but it’s not the only thing that makes it great. Let’s take a closer look at each of its benefits.
Your money grows tax-free
When choosing between Roth or a traditional IRA, here’s a general rule of thumb: If you think you will be in a higher tax bracket when you retire, choose Roth. You will pay taxes now, but at a lower rate because you are potentially in a lower tier.
At Roth, the money you earn from investing is also tax deductible if you withdraw your earnings on retirement. For this reason, Roth is especially useful if you join the company when you are young or early in your career. Your money has more time to grow, and since you will be in the higher tax bracket when you retire, you will get more for your money by paying your taxes now. In addition, there are certain income limits for Roth funding. Once you start earning over $ 116,000 (Adjusted Gross Income), you will only be able to deposit a limited amount. You might as well go in and start saving as long as you are eligible.
The Roth Tax Advantage will also help you hedge against future tax increases. There is no way to know for sure if the federal tax rate will rise in the future, but if it does, you have already paid taxes at a lower rate with your Roth.
You get more access to your money
If you have a traditional IRA, you can withdraw your premiums early without paying a penalty, but only for a few specific reasons , such as when buying your first home. Of course, you still have to pay taxes on this money as it has been deferred.
On the other hand, with a Roth IRA, you don’t need a particular reason to withdraw your contributions: you can withdraw money you deposited whenever you want (you cannot withdraw profits , but you can withdraw the same amount of money that you deposited directly). There is no penalty and you don’t have to pay taxes (you’ve already paid them!). This liquidity can be a great asset.
For example, let’s say you’ve always wanted to live in a different country, so you are saving up for a potential move. You are not sure when you will need the money, or even if you will need it (maybe you will find a job there), but either way, you want to save some money for a potential move within the next five years. This is a medium to long term goal, and it might make sense to save in a taxable investment account so you can make a decent profit. However, it might be a better idea to save that money in your Roth IRA. That way, you get a return on your investment, plus a tax advantage, plus no penalties if you do decide to move and need to collect your money. You cannot do this with a traditional IRA.
Borrowing money from retirement age is not a good idea, but that doesn’t mean you will borrow: it’s just keeping your savings for non-retirement purposes in your Roth. If you are looking for a place to save money to achieve your goal, the Roth account is a liquid option with tax benefits.
You can qualify for a contributor bonus
The Roth IRA has another tax-related benefit: a little thing called a “Depositor Credit”. This is a tax credit for low- and middle-income taxpayers who also have a Roth IRA. Depending on your income, you can borrow up to 50 percent of the first $ 2,000 you save on your IRA. Thus, you can claim up to $ 1,000 in tax.
However, there is one caveat to keep in mind: this is a “bad credit”, which means it will deduct your tax owed to zero, but you will not receive a refund. Second, there are income limits. According to the IRS, the 2015 thresholds are:
Many taxpayers are unaware of this loan. Of course, if you are earning a moderate or low income, you may not be able to save much for retirement. But if you qualify and can afford to spend at least a little money, this is a big bonus worth considering.
No mandatory minimum allocation
Most retirement accounts require you to withdraw a certain amount of money when you reach a certain age. This is called Mandatory Minimum Allocation or RMD. The problem is that you may not need all this money, and withdrawing it means that you will have to pay taxes on that money. This may push some people into a higher tax bracket.
Not a problem with Roth IRA that doesn’t include the required minimum distribution. You have the ability to extract as much (or little) money every year.
Roth IRA Backdoor for Ineligibles
Unfortunately, not everyone is fully qualified for the Roth IRA. In 2015, you can save up to $ 5,500 on your Roth if you make less than $ 116,000 ($ 183,000 if married together). This is the total contribution limit: $ 5,500. However, this limit is gradually reduced if you earn between $ 116,000 and $ 131,000 ($ 183,000 to $ 193,000 if married together).
However, there is a way around this: it’s called the Backdoor Roth IRA . With this technique, you fund a traditional IRA and then convert it to Roth. At the moment, there is no limit on the income to convert, so you can fund Roth this way. There are a few mistakes you can make with the backdoor method, and Morningstar removes some potential obstacles . However, if you are careful and follow the rules, this is a perfectly legal way to fund an IRA when your income exceeds the threshold.
The Roth IRA is popular for a reason: it offers many great benefits. However, a traditional IRA still has tax advantages and the tax deferred benefit is large. If you are saving money for a big purchase in the near future, avoiding taxes will help you achieve this goal faster.
In any case, the most important thing is that you save for retirement to start. There are several perks that come with Roth, but nothing beats achieving financial independence.