What Is a Roth IRA and Should Your Retirement Plans Include One?

What Is a Roth IRA and Should Your Retirement Plans Include One?

Recent surveys indicate that fewer than 15 percent of Americans have a traditional pension, and only about 40 percent of employees contribute to any type of individual pension plan. For years, people were encouraged to contribute to 401K plans, but most employees don’t.

Since 401K retirement plans are not working as intended, many employees are exploring other ways to fund their retirements. Both regular IRAs and Roth IRAs offer employees ways to save money that will be needed once they retire. But, which type of IRA is the best one for meeting your retirement goals?

Both forms of IRAs offer benefits anyone saving for retirement must consider. However, there are differences that will certainly make one option more viable than the other for many savers. Let’s explore both types of IRAs. At that point, it will be easier to see which one is best for meeting your retirement objectives.

What is a Roth IRA?

A Roth IRA has an exciting benefit all savers need to consider. With a Roth IRA, the money you save grows tax-free. Because the account is funded using after-tax dollars, the money is not taxed again as you withdraw it.

Think about that for a moment. Yes, you pay taxes on the original income, but there are no taxes assessed on the earnings. That means your tax burden after retirement, when most people are earning considerably less, is not impacted by your Roth IRA.

What’s the Difference Between the Two Types of IRAs?

The big difference is when the taxes are assessed. As already explained, a Roth IRA is funded with after-tax dollars. Traditional IRAs, on the other hand, are taxed when the money is withdrawn after you retire.

That may be advantageous to some investors, but many retired individuals face an untenable tax burden if the taxes are levied after they retire. Again, there are also advantages, to traditional IRAs, but many retirees feel they’re paying too much in taxes with a traditional IRA.

Other Advantages of Roth IRAs to Consider

Most investment advisors like Roth IRAs because the plans allow savers more flexibility than traditional IRAs. For example, investors may be able to withdraw funds from a Roth IRA without penalties if the funds are used for a qualifying reason. Once you’ve reached the age of 59 ½, there are no penalties assessed for any reason.

With a traditional IRA, investors must begin withdrawing the funds by the time they reach 70 ½, and those savers cannot make any additional contributions after that point. On the other hand, savers can contribute to their Roth IRA as long as they wish to do so. That’s not always important, but many people have other investments that may create tax consequences that might be helped by taking advantage of the possibilities offered by a Roth IRA.

Who Can Take Advantage of a Roth IRA?

This is where things get a little complicated. Not everyone can contribute to a Roth IRA. The qualifications relate to your modified adjusted gross income as reported on your taxes. You must have taxable income, but the amount of that income will vary depending on your filing status. If you’re married, filing jointly, and earn less than $194,000, it’s likely you’ll be able to contribute.

Single individuals or some people married couples not filing jointly are likely to be qualified to contribute to a Roth IRA if their income is less than $132,000. There are specific circumstances that can create issues, so it is always a good idea to verify your eligibility to fund a Roth IRA with an account or other financial advisor when considering different retirement savings options.

How Soon Can Investors Withdraw Money from a Roth IRA?

As noted earlier, there are quite a few ways savings in a Roth IRA can be accessed prior to retirement, but that’s not a good idea. Remember, the idea is to fund your retirement. When funds are withdrawn early, the amount available after retirement can be impacted significantly.

If you’re younger than 59 ½, it’s not a good idea to withdraw any funds unless it’s absolutely necessary. Once you reach that magic age, however, it’s far easier to access the funds as they’re needed to fund your retirement plans.

Traditional IRAs can be tapped into at age 59 ½, but withdrawing funds prior to that time will generally result in rather stiff penalties. Any funds withdrawn before age 59 ½ will be included in your gross income, and a ten percent penalty will also be assessed unless specific conditions are met. In some hardship situations, the penalties may be waived, but don’t assume that will happen without verifying the situation qualifies.

At What Point Must Investors Withdraw Funds from a Roth IRA?

The short answer is whenever you want to. The government has already collected the taxes on your investment and they really don’t care when you make withdrawals once you’ve reached that 59 ½ age threshold.

So, Which IRA Option Should Investors Consider?

As noted earlier, there are some income requirements for individuals wishing to fund a Roth IRA. If your income is greater than those requirements, it’s pretty obvious a standard IRA is the only real option available.

Roth IRAs are considered beneficial for savers who expect their tax rates to be higher in the future. Today’s lower tax rates means the money invested now is cheaper and will produce higher long-term returns.

It’s also important to remember that situations always change, and investment advisors generally recommend diversifying your investments to cover as many bases as realistically possible. That might mean having more than one type of retirement account and adjusting the contributions to each one as your situation evolves.

In the vast majority of cases, a Roth IRA will provide substantial benefits for investors, especially younger individuals, and should be a part of an overall retirement plan. The best way to determine whether a Roth IRA is really the best option for your situation is to discuss your retirement savings options with a financial advisor now.