Roth individual retirement accounts allow you to pay income tax on your retirement savings upfront, so you won’t be stuck with a tax bill in retirement when you can least afford to pay it. Roth IRA owners are often allowed to take tax-free distributions in retirement and can completely avoid paying taxes on their investment growth. Here are the reasons you should consider contributing to a Roth IRA.
Prepay your retirement tax bill.
You contribute dollars that you have already paid taxes on to a Roth IRA. So, Roth IRAs are often especially beneficial for people who are in low tax brackets. Even if you jump into a higher tax bracket later or if tax rates are raised, you already paid taxes on your Roth contributions and likely won’t have to again. All of the money in a Roth IRA will generally be available for spending in retirement, unlike a traditional IRA where you will owe income tax on each withdrawal.
Tax-free withdrawals in retirement
Roth IRA distributions that are taken after age 59 1/2 from accounts that are at least five years old are tax-free. In contrast, you will owe income tax on each withdrawal from traditional IRAs and 401(k)s. When deciding between a traditional or Roth IRA, it can be helpful to compare your current tax rate to what you expect your tax rate to be in retirement. You can also save in both types of accounts in the same year and hedge your bets about future tax rates.
Tax-free investment growth
Roth IRAs can help you to keep more of the investment growth on your retirement investments. You don’t have to pay income tax on investment gains or interest earned within your Roth IRA each year. And if you wait until after age 59 1/2 to take distributions and your account is at least five years old, you won’t ever have to pay tax on your Roth IRA investment earnings. This is significantly different from a traditional IRA, where you owe income tax on each withdrawal, including on the investment earnings.
More flexibility in retirement
Withdrawals from traditional 401(k)s and IRAs are required each year after age 72. You must take required minimum distributions from traditional retirement accounts each year and pay the resulting tax bill, and there is a 50% tax penalty if you miss a distribution. But Roth IRAs don’t have any withdrawal requirements during the lifetime of the original account owner. You can choose to withdraw the money or leave it in the account. The money can continue to grow tax-free for the rest of your life.
Easier access to your money before retirement
Traditional IRA withdrawals before age 59 1/2 result in a 10% early withdrawal penalty in addition to income tax on the amount withdrawn. Roth IRA early withdrawals trigger a 10% penalty and income tax only on the portion of the withdrawal that comes from investment earnings. You can withdraw funds you contributed to the Roth IRA without penalty if the account is at least five years old. As with traditional IRAs, penalty-free early withdrawals are allowed for a variety of reasons, including college costs, first-time homeownership expenses, health insurance premiums after job loss and significant unreimbursed medical costs.
Leave tax-free money to heirs.
If you leave a large traditional retirement account balance to a beneficiary, you may also be passing on a large tax bill. Beneficiaries must pay the taxes on money you leave to them in a traditional 401(k) or IRA. However, your children and grandchildren can take tax-free withdrawals from the Roth IRA they inherit from you. While heirs will need to take withdrawals from a Roth IRA, the distributions are less likely to trigger an expensive or complicated tax situation for your beneficiaries.
Maximize tax-sheltered assets.
The money in your traditional 401(k) or IRA doesn’t completely belong to you because you still owe taxes on it. But you have already paid taxes on all the money in your Roth IRA using money outside of your retirement accounts, which allows you to shelter as much money as possible from taxes within the account. All the money in your Roth IRA will be available for spending in retirement or passing on to your heirs.
Later contribution deadline
Retirement savers can contribute up to $6,000 to a Roth IRA in 2022. Workers age 50 and older can make an additional $1,000 catch-up contribution for a total Roth IRA contribution of $7,000. While 401(k) contributions are typically due by the end of the calendar year, you can make Roth IRA contributions up until the tax-filing deadline in April. When you contribute to a Roth IRA between January and April, you can elect to apply the deposit to the current calendar year or previous tax year.
Roth IRA conversions
There are income limits for Roth IRA contributions. Those who earn more than $144,000 as an individual or $214,000 as a married couple can’t directly contribute to a Roth IRA in 2022, and eligibility is phased out for workers earning more than $129,000 as individuals and $204,000 as couples. However, almost anyone can convert traditional IRA assets to a Roth if they are willing to pay income tax on the amount converted. This maneuver is particularly beneficial if you make the conversion and pay the resulting tax bill in a year when you are in a particularly low tax bracket. You can also convert a small amount each year to avoid an abnormally large tax bill.
Get the saver’s credit.
While Roth IRA contributions won’t get you a tax deduction, they can qualify you for the saver’s credit. If your income is below $34,000 for individuals, $51,000 for heads of household and $68,000 for couples in 2022 and you contribute to a Roth IRA, you may be eligible for a tax credit. The saver’s credit is worth between 10% and 50% of the amount contributed to a retirement account up to $2,000 for individuals and $4,000 for couples. The biggest credits go to retirement savers with the lowest incomes.
10 Reasons to Save for Retirement in a Roth IRA:
— Prepay your retirement tax bill.
— Tax-free withdrawals in retirement.
— Tax-free investment growth.
— More flexibility in retirement.
— Easier access to your money before retirement.
— Leave tax-free money to heirs.
— Maximize tax-sheltered assets.
— Later contribution deadline.
— Roth IRA conversions.
— Get the saver’s credit.
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Update 04/11/22: This story was published at an earlier date and has been updated with new information.