Is a Roth IRA Right For You?

Many Americans’ Golden Years are not quite golden. A June 2015 government accountability office analysis found that the average Americans between the ages of 55 and 64 have accrued about $104,000 in retirement savings. This amount would translate into a very low $310 monthly payment if your money were invested in a lifetime annuity.

Ways to Grow Your Retirement Savings

To grow your retirement’s nest-egg you need to start saving early on while you are still in your 20’s, max out the contributions to your IRA or employer sponsored 401K, make sure to make any catch-up contributions after you turn 50, and avoid any early withdrawals from your accounts if possible. Taking these steps may dramatically increase your chances for financial freedom in your Golden years.

Roth IRA vs. Traditional IRA

In the past decades, Traditional IRA contributions were more popular than Roth IRA contributions. However, in recent years the trend has changed and now more money is being deposited into Roth IRA accounts. Roth Accounts are especially popular with young workers (ages 24-35), though those with Traditional IRAs may want to consider the benefits of a Roth IRA conversion.

The question is: why are Roth IRAs more popular? Well, Roth accounts offer four major benefits that may make opening a Roth IRA or doing a Roth conversion a smart choice:

1. Tax Benefits – you don’t have to pay any capital gains or dividends on your investments. In addition to that, any qualified withdrawals you make during retirement are tax free. One of the benefits of the Roth IRA’s tax-free withdrawals is that they protect you from income tax raises. Contributing to a Roth IRA could allow you to avoid paying higher taxes in the future.

2. No Minimum or Maximum Age Requirements – you can contribute to a Roth IRA so long as you have earned income, even if you’re 100 years old or you’re a minor with income. If you’re 14 and work a summer job, then you can contribute to a Roth IRA as well, giving you the potential for many years of tax-free growth. You’re also not required to begin taking distributions from your Roth IRA at any age. If you don’t need the money, you can leave it alone and enjoy additional years of tax-free compounding, which can have an enormous effect over the years. Let’s say you retire at age 70 with a $500,000 Roth IRA. If you leave your Roth IRA alone and it compounds at a conservative rate of 6% per year, then the account could be worth $1.2 million by the time you reach age 85. The fact that you never have to withdraw funds from a Roth IRA makes it an excellent vehicle for building an inheritance for your loved ones.

3. Good for Estate Planning – A Roth IRA can also be an effective estate planning tool as it cannot only allow your money to grow tax-free for your entire life, but also let you leave tax-free income to your heirs. Although your heirs will be subject to minimum distributions based on their age beginning in the year after your death. A Roth IRA can be an effective way to “prepay” taxes for future generations. Plus, given that you owe no taxes on your Roth contributions, setting aside as much as possible in a Roth can reduce the size of your taxable estate.

4. Freedom to Use Funds – Your Roth IRA contributions (not any investment gains) can be withdrawn at any time and for any reason. For example, if you have contributed $5,000 to a Roth IRA each year for 10 years, then you can access $50,000 of your savings whenever you need to. Basically, your Roth IRA can be a retirement plan and an emergency fund in one. Note: if your withdrawals include investment gains, you’ll be responsible for paying income tax on the gains unless you’re over age 59-1/2, so keep this in mind before choosing to withdraw more than your original contributions early.

So, what if you only have traditional IRA accounts?

The IRS now allows you to convert IRAs to Roth accounts. The Roth conversion offers several benefits such as; eliminating federal income tax on all future withdrawals including any gains accumulated, having your funds grow tax free during your lifetime, avoiding the required minimum distributions during your lifetime, and leaving the IRA as a tax-free bequest to your heirs.

You can also do a partial Roth conversion and if something happens—like your tax rate goes down or you can’t afford the immediate tax hit—you can recharacterize your Roth IRA and revert to a traditional IRA, but there are restrictions and deadlines involved.

You should consult your tax advisor before you convert IRAs to Roth accounts. There are many considerations to make, such as your projected income in the future, life expectancy, your cash flow, your current age and the types of income you have (capital, passive, ordinary).

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