What’s good about a Roth IRA?

Is a Roth IRA worth it? Find out the benefits you will get with a Roth IRA, and how it compares to a traditional IRA.

3 min read

A Roth IRA is a popular retirement option among millennials who expect their income to increase over their working life. The main difference between a traditional IRA and a Roth IRA is when taxes are paid, and how much taxes you pay. For a Roth IRA, taxes are paid upfront when you contribute, and this provides investors with a better strategy to legally minimize their taxes. Retirement savers get multiple benefits when they use a Roth IRA to save for retirement.

A Roth IRA offers retirement savers multiple benefits including tax-free income in retirement, early access to retirement savings, and better terms for beneficiaries. Also, retirement savers are not required to take the required minimum distributions from a Roth IRA when they reach age 72. If you are 70 ½ or older, you can still contribute to a Roth IRA and rollover traditional IRA contributions to a Roth IRA.

Benefits of a Roth IRA

If you are wondering what’s good about a Roth IRA, here are some of the benefits you will get when you use a Roth IRA:

Tax-free income in Retirement

One of the perks that make Roth IRA grow in popularity is the promise of tax-free retirement income. Once you retire, you won’t pay taxes when you withdraw your Roth IRA contributions and any investment earnings in the account. These funds will grow tax-free over your working years. Once you retire, you won’t pay any taxes or penalties on the distributions you take from the account.

Unlike a traditional IRA that gives retirement savers a tax break when they contribute to the account, the Roth IRA is funded with after-tax dollars. This means taxes have been taken out when the investor contributes to the Roth IRA. For example, if you have accumulated $1 million when you retire after age 59 ½, you can withdraw the $1 million without expecting a tax bill from the IRS. 

Early access to retirement savings

A less popular feature of a Roth IRA is the ability to withdraw your contributions tax-free even if you are below age 59 ½. Since a Roth IRA is funded with after-tax dollars, you can withdraw the contributions in the account at any time without triggering taxes and penalties. Only the earnings generated will be subject to taxes if you were to withdraw these funds before retirement.

For example, assume that you have contributed $10,000 to the Roth IRA, and the contributions have generated earnings of up $3000. If you are short of money, you can withdraw the $10,000 at any time, without owing any taxes and penalties. However, if you exhaust the contributions and go for the investment earnings generated from your retirement savings, it will trigger taxes and penalties.

No RMDs with Roth IRA

Generally, the IRS makes it mandatory for retired workers to start taking the required minimum distributions (RMDs) from most retirement accounts once they reach age 72.

For traditional IRAs and 401(k) accounts, RMDs would potentially increase your tax bill and also impact other benefits like Medicare premiums. However, Roth IRAs do not require account holders to take RMDs when they reach age 72. If you have sufficient funds to meet your expenses, you can leave the money untouched until when you need it.

Better terms for beneficiaries

Retirement savers can use a Roth IRA as an estate planning tool so that their beneficiaries can inherit tax-free money. If you have accumulated more than you will need for your retirement, you can leave some of the money for your next generation.

Once you pass away, the beneficiaries can inherit your Roth IRA, and spread the inheritance over their lifetime. The beneficiaries will not owe any taxes on any distributions they take from the inherited Roth IRA.

Backdoor Entry for High Earners

Generally, anyone with earned income can contribute to a Roth IRA but you become ineligible to contribute if your income exceeds the IRS limits for Roth IRA. For 2021, you cannot contribute to a Roth IRA if your income is above $140,000 for single filers or $208,000 for married couples filing jointly.

If your income exceeds the IRS limits, you are ineligible to make direct contributions to the account. However, you can use a strategy known as Backdoor Roth IRA to work around these limits. This strategy involves contributing to a regular IRA, and converting the IRA to a Roth IRA. You will pay taxes on any deductible contributions and investment earnings in the Roth IRA account before the conversion.

Contributions after 70 ½

With a 401(k) and traditional IRA, you are not allowed to make further contributions once you reach 70 ½. However, this is different with a Roth IRA, which allows retirement savers to continue making contributions to the account even after 72. Since the Roth IRA does not require RMDs, you can leave the money in the account for as long as you live.

Should You Open a Roth IRA?

If you are struggling with tax bills, a Roth IRA may not be the most ideal retirement account since it will mean more taxes for you. Instead, you can use a traditional IRA to get a tax break and lower your taxable income. However, you will still owe taxes when you take a distribution in retirement.

A Roth IRA may be most appropriate if you are young, and expect your income to increase over your working years. A Roth IRA provides valuable perks that can motivate you to save more and plan for your retirement. Paying taxes now will ease your tax burden in retirement.