Is There Anything Better Than a Roth IRA?
If your tax rate will decrease significantly upon retirement, a Roth account could be the right solution. There are even strategies available that help lower taxable income prior to saving in an IRA or 401(k).
Once your account has been in existence for at least five years, both contributions and earnings can be withdrawn without incurring income taxes or early-withdrawal penalties.
1. Tax-Free Growth
Roth contributions differ from traditional retirement accounts by coming from earnings after you’ve paid income taxes; and, thus, your money grows tax-free in your account. This can be especially advantageous if you anticipate being in a higher tax bracket in retirement.
At age 59 1/2 and after five years in your account, withdrawals from investments become tax-free and do not incur an early withdrawal penalty. Any withdrawals prior to that age are taxable and could incur an early withdrawal penalty.
Thrivent Financial Advisors can explain all of the details and help you decide if a Roth IRA is appropriate for you. They can even assist with converting existing retirement accounts, though any funds converted during this process will be taxed as regular income in that year.
2. No Penalties for Early Withdrawals
Roth accounts are unlike traditional IRAs in that you do not need to begin withdrawing the money at age 72; rather, your earnings can continue to accumulate tax free until it comes time for withdrawal.
However, any large withdrawals should be carefully considered if you are under age 59 1/2. Withdrawals before age 59 1/2 will incur income taxes and a 10% penalty; exceptions could include paying for your first home with funds from early withdrawals.
If you anticipate being in a higher tax bracket during retirement, a Roth IRA might make sense; however, no one can truly predict your tax rate in advance. On the other hand, retirees with lower expected tax rates might find traditional IRAs to be better options.
3. More Options for Investments
While it might be counterintuitive to save for retirement with after-tax dollars and expect their tax rates to increase once retired, Roth accounts can be an effective strategy for those expecting their tax rates to become higher later on in life. By funding them with after-tax funds and paying taxes when withdrawals come out in retirement, a Roth account could significantly decrease taxable income over time.
Young workers are well suited to reap the benefits of Roth accounts as their tax rates tend to be lower early on in their career. Prepaying taxes at lower rates allows them to prepaid taxes more easily while any capital gains accumulated within their accounts can be withdrawn tax free.
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4. Flexibility for Withdrawals
Roth IRAs offer more flexibility than other retirement accounts in that you can withdraw contributions at any time and aren’t subject to taking an RMD at a specific age, which could come in handy should your tax rates rise over time.
But if you withdraw earnings before retirement, they’ll be subject to income taxes and a 10% penalty, potentially pushing you into higher tax brackets and raising Medicare premiums in the process.
Idealistically, money saved for retirement should remain safely put away until its time to use. But in an emergency situation, having access to your funds without incurring penalties makes a Roth IRA an attractive retirement savings tool that works no matter your tax bracket.