Chances are you’ve heard of a Roth IRA, a special kind of retirement account that is funded using after-tax dollars. But have you started one? Ugh. Retirement planning. Honestly, do we have to talk about that now? Yes we do. There are some uber awesome benefits to opening a Roth IRA that will help jump start your retirement, especially if you are just getting started. Just give me a few minutes, I promise to be quick.
Backstory – William V. Roth, Jr.
The Roth individual retirement arrangement (Roth IRA) is less than 20 years old. It was established by the Taxpayer Relief Act of 1997 and named after U.S. Senator William Victor “Bill” Roth, Jr. of Delaware, the Harvard educated attorney who sponsored the bill. Senator Roth’s political career was marked by over four decades of service, achievement, and advocacy as a relentless champion of tax cuts and wasteful government spending. As Chairman of the Senate Finance Committee, he fiercely promoted the core values of saving for home ownership, education, and self-reliance in retirement through the retirement vehicle that still bears his name.
Today, the Roth IRA is a cornerstone of many American retirement portfolios. There are income limits and certain restrictions on a Roth we’ll talk about later. In the meantime, take a look at the stats. Roth assets in Individual Retirement Accounts in the United States from 2000 to 2013 increased by 547.44% from $78 billion to $505 billion respectively (source). Considering the many unique advantages of the Roth RIA helps explain its uber appeal.
Four Uber Awesome Benefits & Guidelines of the Roth IRA
- Age doesn’t matter. Seriously. You can start a Roth IRA whether you are 17 or 71 years of age. The same is not true for a Traditional IRA which places an age limit restriction on individuals a 70 ½ years of age and older. If you fall into the latter age category, you can open a Roth IRA but not a traditional IRA. A little confusing, I know. The simple fact that Roth IRA’s are age friendly makes it accessible to broader range of investors, both young and old, looking to sock away money for retirement, higher education and even for a first-home or a rainy day. But it’s not a slam dunk. Related Retirement First and Fantasy Last As with any retirement investment vehicle, there are certain requirements which must be met. We will include several guidelines that apply to Roth IRAs later in this post.
- No penalties and income-tax on early withdrawals, usually. Have a family emergency or unforeseen expenses like loss of a job? Roth to the rescue! Early withdrawals from a Roth IRA are free from income-tax penalty because the money you deposit into a Roth IRA has already been taxed. So you can withdraw contributions you made to your Roth IRA anytime, tax and penalty free! This may help to provide an investor with peace of mind, knowing there is money readily available in case of an emergency. But watch out, the earnings on that same money follow a different set of tax rules. Unless you are over 59 1/2 and have held the account for a period of five-years, you’ll end up paying a 10% penalty and additional income tax on the withdrawals of those investment gains.
- Terrific tax & estate planning benefits. How does a tax-free retirement sound to you? A Roth IRA will provide it to you. Remember, the contributions in a Roth consist of money that has already been taxed. That’s win number one. Now let’s look at growth. Earnings will also get to grow tax-free, provided they stay put for a period of at least 5 years. That’s win number two. Lastly, parents can leave their Roth IRA to their heirs when they pass on and bypass probate all together. As an estate planning vehicle, the Roth IRA is very effective saving time and money that might otherwise be spent in probate court. That’s win number three.
- Freedom of choice. A Roth IRA provides an investor with an array of investment choices. Unlike a 401(k) or 403(b) retirement plan at work with a limited selection of funds, the Roth offers total freedom of choice to choose the types of investments what you want. These may include a mix of individual stocks and bonds, mutual funds, exchange traded funds, index funds, REITs, commodities like gold, oil, and coffee, even cash and cash equivalents such a money market fund. Rookie investors can self-manage a Roth IRA and pick the investments on their own, should they choose. The alternative is to use a low-cost automated solution like SheCapital Get Started to do it for you or hire a financial advisor to help make the investment selections on your behalf.
Before I let you go, it’s important to review some general guidelines pertaining to Roth IRAs so you don’t get tripped up.
- Consult with your financial advisor or accountant before you open a Roth IRA. Make sure you’re clear on the difference between contributions (what you put in) and earnings (the amount of growth) and the specific rules relating to withdrawals. You don’t want to be blindsided by an unintentional penalty or income tax payment.
- Yearly contributions limits are different according to age and tax year. In 2015, if you’re under age 50, you can contribute up to $5,500. For investors age 50 and older, you can contribute up to $6,500. In both cases, it is assumed you have earned income of at least $5,500 and $6,500 respectively.
- Not everyone is eligible for a Roth IRA. There are income limits relating to Roth IRA that change each year. Single filers must make less than $116,000 to contribute to a Roth IRA in tax year 2015. Married filing joint or as a qualifying widow(er), must earn less than $183,000 to contribute up to the maximum limit. Yes, there is a way around it called a back-door Roth you can explore with a financial professional.
- There are additional exceptions. There are some exceptions for taking a distribution from a Roth IRA you should be aware of. For example, if you are a first-time home buyer, receiving disability, or have qualified education expenses. So make sure to share all facts that are relevant to your life with a financial advisor.
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