Do you think you would be able to live on the average Social Security benefit of $1,522 per month in retirement? If your answer to that question is no, you’re almost certainly going to need to supplement your benefit checks with your own savings and investments. The type of investments you choose and the type of accounts you manage them in will be important and could make all the difference in whether you feel financially secure in retirement.
With all that in mind, here are three great reasons why you should consider keeping those funds in a Roth IRA.
1. It could save you money on taxes
You pay taxes on your Roth IRA contributions in the year you make them, but you will be able to take withdrawals — both of contributions and any gains — tax-free in retirement. So these accounts are a good fit if you think you’re earning about the same or less than you’ll spend annually in retirement. By paying taxes now on just your contributions, you’re setting yourself up to give the government less in the long run.
In addition, because your Roth IRA withdrawals don’t count toward your taxable income, using one can help you minimize potential taxes on your Social Security benefits. The federal government can tax your benefits if your combined income — your annual adjusted gross income (AGI), any nontaxable interest, and half of your Social Security benefits — exceeds $25,000 for an individual or $34,000 for a married couple. Some states tax Social Security benefits as well, though each has its own formula to determine the level of taxation.
A Roth IRA will help you keep your AGI low while still allowing you access to your retirement savings. Using one doesn’t guarantee that you’ll avoid having to pay taxes on your Social Security benefits, especially if you’re earning income from a job or taking withdrawals from tax-deferred retirement accounts as well, but with careful planning, it may help you shave a little off your tax bill.
2. It gives you a lot of flexibility
Roth IRAs give you many more options in terms of what you can invest in than employer-sponsored retirement plans such as 401(k)s do. This translates to greater control over what you’re paying in fees. Further, if you do your research and invest your money wisely, you may be able to earn better returns with a Roth IRA than you could with a retirement plan that has limited choices.
You can contribute to a Roth IRA at any age as long as you or your spouse is earning enough income to cover your contributions. The only thing that might prohibit you from placing money directly into a Roth IRA is if your income exceeds $139,000 for an individual in 2020 or $208,000 for a married couple filing jointly. These limits will rise by $1,000 and $2,000, respectively, in 2021. If you’re one of these high earners, you can’t contribute directly to a Roth IRA, but you can set up a backdoor Roth IRA by contributing to a traditional IRA and later doing a Roth IRA conversion.
There is at least one way in which Roth IRAs offer less flexibility than other tax-advantage retirement accounts: They have lower contribution limits. The maximum is $6,000 annually in 2020 and 2021, or $7,000 if you’re 50 or older. That’s not an issue if you’re not making new contributions to your Roth IRA, but for older adults who are still working, you must be careful to stay below the annual limit.
3. You can leave the money in your account as long as you want
If you are able to cover most or all of your retirement expenses with Social Security, you’ll probably prefer to leave your personal savings untouched so they can grow and be worth more to you or your heirs in the future. In that case, a Roth IRA is a smart place to keep your retirement funds because it’s the only retirement account that’s exempt from required minimum distributions (RMDs).
These are mandatory withdrawals you must begin taking at 72 if you were born after Jun. 30, 1949, or at 70 1/2 if you were born before this date. The rule is the government’s way of ensuring it gets its cut of your retirement savings, but since you’ve already paid taxes on your Roth funds, there’s nothing for the government to take. RMDs can force you to withdraw money you don’t need from your retirement accounts, raising your tax bill and possibly putting you in danger of owing taxes on your Social Security benefits. But not taking RMDs is a worse option: If you don’t, you’ll pay a 50% penalty on the amount you should’ve taken out.
It’s better just to avoid this issue altogether by keeping your extra cash in a Roth IRA until you need it. Use your Social Security benefits to cover your basic expenses and if you run short, withdraw just what you need from your Roth IRA so the rest of your investments can continue growing.
You don’t have to limit yourself to just saving in a Roth IRA for your senior years. Other types of retirement accounts also offer tax benefits and some, like 401(k)s, have higher contribution limits that enable you to invest more. But a Roth IRA does offer some distinct advantages that those other options don’t, so it’s definitely worth opening one if you haven’t already.