The Roth individual retirement account is a fantastic investment vehicle that many people should consider as part of their overall retirement plan. Why? Here are nine winning reasons to open a Roth IRA, from Alison Davies, certified financial planner at Fruition Advisors and contributor at Investopedia.com.
(Editor's Note: This article originally appeared at Investopedia.com.)
Roth IRAs have the same benefits of tax-free growth as traditional IRAs.
Roth IRA contributions come from after-tax money. This means you've already paid the taxes on this money before you make your contribution. This is why there is no tax deduction for your contribution (unlike a traditional IRA contribution). However, there is a tremendous benefit you receive from paying the taxes on the front end — you don't have to pay taxes on the back end when you make withdrawals.
If tax rates increase in the future (highly likely based on historical data), or if your tax rate in retirement will be higher than your tax rate now, a Roth IRA could be a banner idea. Investors who expect to have a higher tax rate in retirement have the most to gain with a Roth IRA, because you pay lower taxes on contributions now to avoid higher taxes on withdrawals later.
This is particularly true for younger investors. The younger you are, the more earning potential you have and the more chance your income will be higher at retirement. Put another way, the greater the difference between your income now and your income in retirement, the more advantageous a Roth IRA can be.
After age 70½, traditional IRA account owners are required to take annual distributions from their account and pay the resulting income tax each year. It can be undesirable to take money out of an investment account if it is not immediately needed, and pay income tax on it.
Additionally, the penalty for failing to withdraw the correct amount is a whopping 50 percent of the amount that should have been withdrawn in addition to the income tax due. On the other hand, Roth IRA account owners are not required to take annual distributions, which gives them more flexibility to time withdrawals with needs, achieve growth and pass on tax-free money to their heirs.
No matter how old you are, as long as you have earned income, you can contribute to a Roth IRA. With traditional IRAs, you can't contribute if you are older than age 70½.
A Roth IRA enables you to take out 100 percent of what you have contributed at any time and for any reason, with no taxes or penalties.
Roth IRAs can help you better manage your tax liability in retirement. For example, you can take distributions from your traditional IRA up to the limit of your tax bracket, then take the rest from your Roth IRA without jumping up a tax bracket.
Since Roth IRAs don't have required minimum distributions, they can increase significantly in value over the years for your heirs. With traditional IRAs, beneficiaries must pay taxes on the money they withdraw. With Roth IRAs, beneficiaries can receive tax-free distributions of the money left to them.
There are income limits for Roth IRA contributions, but investors who exceed these limits may still be able to contribute to one by converting money from other retirement accounts.
Please consult your financial advisor to assess if a Roth IRA is right for you.