The Roth IRA has often been called the holy grail of retirement accounts, and there are good reasons why. It’s a magic bullet for savers who want to use money they’ve already paid taxes on to invest in assets that can supercharge their portfolio growth.
Although the Roth IRA is often touted for the unique combination of benefits it offers to retirement savers, some of its perks often go overlooked. Here are four that you should know about.
1. You’ll gain access to potentially unlimited tax-free income in retirement
The promise of tax-free income during retirement is attractive to many savers. It’s one of the main reasons that the Roth IRA continues to grow in popularity. As long as your income falls below the limits — and you’ve earned income during the year — you can contribute more to your account and generate more tax-free growth down the road.
Here’s how it works. Whether you have your contributions taken directly out of your paycheck or you make them later, you will have already paid taxes on the money that goes into a Roth IRA. Those funds will grow tax-free, and in retirement, you will pay no taxes on the money you withdraw.
Annual contributions, however, are capped. For 2021, the maximum contribution is $6,000 for those under 50 and $7,000 for those 50 or over. (You’re also not allowed to contribute more than you’ve earned for the year.)
Let’s say you make an annual contribution of $6,000 for 40 years. That’s a total investment of $240,000. Within your account, you will be investing that money steadily. Because time and compound growth are a powerful combination, with just a 7% annualized rate of return (which is not unreasonable) that portfolio’s value will grow to more than $1 million.
Once you’re eligible to make withdrawals from your Roth IRA tax- and penalty-free at 59 1/2, you can enjoy the entire $1 million without worrying about a tax bill from the IRS — as long as you’ve checked the box on the five-year rule.
2. You can always withdraw what you’ve contributed without tax or penalties
A lesser-known feature of the Roth IRA is the ability to withdraw your contributions whenever you want. This may sound too good to be true — especially if you’ve been warned not to touch any money in your retirement accounts until you’ve reached your golden years. But there’s some flexibility with the Roth IRA that makes it a bit more compelling than other investment vehicles.
Let’s say you contribute $5,000 to a Roth IRA and the value of your investments grows to $7,000. If you find yourself in need of money, you can always take out the original $5,000 whenever you want — no questions asked. It’s the $2,000 worth of earnings in your account that would set off the alarm and trigger taxes and penalties. But here’s the catch: Once you take money out, you can’t pay it back into the account later.
3. You don’t have to worry about required minimum distributions
When you’re in your 70s, you may appreciate this benefit a bit more: Roth IRAs have no required minimum distributions (RMDs).
RMDs are minimum mandated amounts that investors must withdraw from tax-deferred retirement plans after they turn 72. With other types of accounts, these distributions are subject to ordinary income tax, so RMDs can jack up your tax bill. This could be a pain point for retirees with multiple sources of income who may not want to be forced to withdraw retirement funds that they don’t need yet from their tax-advantaged accounts.
With a Roth IRA, there’s no need for anxiety on that front — you can leave your money in your account for as long as you like. Once you’ve met the account requirements or qualify for the Roth IRA’s pre-retirement benefits, you can do as you please.
4. They offer an easy way to pass on wealth to your heirs
Imagine being in a position where you don’t need to withdraw all (or even most) of your Roth IRA funds during your lifetime. That means that you’ll have the opportunity to put some money toward funding the dreams of the next generation. And once you pass away, your heirs will retain the ability to reap the benefits of your Roth IRA.
An inherited Roth IRA is an incredible benefit that can lead to more tax-free income for beneficiaries. If you’re retired and see it as likely that you won’t completely draw down the balance of your account, you’ll want to start thinking about a Roth IRA inheritance strategy now, so that your beneficiaries can know what to expect and how it works.
Your lucky charm is right in front of you
If you were looking for reasons why you should start saving for retirement now, you’ve just found some.
Think of the Roth IRA as your lucky charm. It’s a retirement account filled with valuable perks that can motivate you to start saving more, investing strategically, and planning for the best years ahead. A financially secure retirement is a benefit that will make your golden years a bit more rewarding.