I recently wrote an article for Interest.com on 5 reasons you should open a Roth IRA now.
Aside from a checking account, it is by far the single best account to have and the best way to save. It’s an Individual Retirement Account that not only provides you with tax-free income in retirement but offers you a lot of flexibility to make penalty-free withdrawals between now and then.
At a time when Americans lack not only retirement savings but emergency savings, the Roth is great because it lets you pull double duty by saving for both in one place.
In a perfect world, you’d never touch the money in a retirement account until your working days are over.
But in these economic times people don’t often have a choice. Everything from layoffs to medical bills can put a pinch on everyone.
If you have to tap most retirement funds, it can get quite expensive.
Withdraw money from a 401(k) or traditional IRA before you reach 59½, and you’ll be hit with a 10% penalty and have to pay income taxes on whatever you take out.
If you need $5,000, for example, you might have to actually withdraw $6,500 because of those penalties and taxes.
That’s not the case with a Roth IRA.
You can withdraw contributions anytime, for any reason, without paying any penalties or taxes.
That’s one of the reasons Mari Adam of Adam Financial Associates in Boca Raton, Fla., says that opening a Roth IRA is one of the best financial moves you can make.
If you’re like most Americans, you’re probably lacking in both your emergency and retirement savings.
So if you have to play catch-up, using a Roth as part of your emergency fund lets you do both simultaneously.
“It gives you flexibility to where if you need it in an emergency or for something important, you can access the principal for any reason tax-free and penalty-free,” Adam says.
Second, a Roth can help you save for college bills and a down payment on a home. This is especially important if you’re young and haven’t yet bought your first home because you can withdraw up to $10,000 to put towards a down payment and not pay any taxes or penalties.
Some parents are using Roth IRAs to hold some of their kids’ college education funds because the contributions can be withdrawns at no cost whenever the money is needed.
They can also tap the earnings and the 10% penalty is waived if it goes to cover a qualified higher education expense. This includes college tuition or expenses for you, your spouse, your child or grandchild.
A Roth IRA is also one of the greatest tax breaks you’ll ever get from Uncle Sam because your earnings can grow tax-free and be withdrawn tax-free in retirement.
Think about it: Your money can grow for decades, and you’ll never be taxed on it.
At 59½ years old, you can start withdrawing from this jackpot when all your friends with traditional IRAs have to pay taxes on every dollar they touch.
If you’re 30 years old and max out your Roth IRA to the current limit for 30 years and average an 8% return, you’ll have $608,000.
If you used the 4% rule, that would provide $24,000 a year, tax-free.
If you were in the 15% tax bracket, and had to pay taxes on your withdrawals, it would be about the equivalent of $30,000 per year.
Of course, contributions to Roth IRAs must be made with after-tax earnings.
This is one of the biggest differences between a traditional IRA and a Roth IRA.
With a traditional IRA, contributions (up to the $5,000 limit or $6,000 if you’re over 50) can be deducted from your earnings, lowering your income tax bill for that year.
But unless you’re in a higher tax bracket, you really wouldn’t see much savings with a traditional IRA anyway.
If you’re in the 25% tax bracket and contributed $5,000 to a traditional IRA this year, you could save up to $1,250 in federal income taxes.
But would you actually save and invest that difference?
Probably not. If you’re like the majority of Americans, it would be absorbed into your annual spending on things like dining out, clothes and cell phone bills.
With the Roth, you won’t save any money in taxes now, but you’ll be able to grow that money for decades and never pay taxes on any of it.
Finally, with a traditional IRA, you must start making withdrawals by age 70½.
There is no such requirement for Roth IRAs. You’d be lucky to be in this situation, but you can hold this tax-free money indefinitely and pass it on to your heirs.