Is a Roth IRA Worth It?

When should you consider a Roth IRA?

I believe almost everyone who can, should have a Roth IRA.

The biggest reason to open and contribute (or convert an existing retirement account) to a Roth is if you expect your future tax rates to be higher. Tax rates can change for many reasons but can be affected because of life changes such as making more money, becoming a surviving spouse, or expecting the current tax rates to sunset and expire as legislated.

If you want to save for college and your own retirement at the same time, a Roth may work for you. If you keep up with your tax basis via IRS Form 8606 – Nondeductible IRAs – you may be able to withdraw the basis anytime for any reason tax free. This basis could be used for college expenses, and any earnings withdrawn before age 59 1/2 but for qualified educational expenses are subject to income tax, but not subject to penalty (per IRS publication 590).

Contributions and Conversions to a Roth IRA today are taxed now at your current tax rate, but then when you withdraw your money in retirement you do not pay federal or state taxes. This means every dollar put in grows tax-free and can be withdrawn tax-free in retirement (as long as you’ve owned the account for 5 years and are age 59 1/2 or older).

Many younger investors, such as those early in their careers, could benefit from exploring a Roth strategy. There are no age limits to opening a Roth IRA, however you (or your spouse) must earn taxable income to be eligible to contribute. There are no income requirements for you to convert a Traditional IRA to a Roth.

If you don’t already have a Roth IRA, the case could be made for anyone to get an account started now because of “the 5-year rule.” Roth IRAs that have been open more than 5 years receive favorable tax treatment in certain circumstances – even if the balance is $1.This means that even if you were to wait to convert or contribute money years from now to the account, having a Roth past its fifth birthday is helpful.

When would a Roth IRA not make sense?

You expect to be in a lower tax bracket in the future. Traditional IRAs are pre-taxed, meaning you get a tax break today and will pay the taxes when you withdraw the money in retirement. In this scenario, every dollar you put in plus the growth are taxed upon withdrawal. Therefore, a Traditional IRA can be more advantageous if you are in a higher tax bracket today and anticipate that your income may decrease during retirement.

If it results in additional costs beyond the taxes from converting money from a Traditional IRA to a Roth IRA. Converting a Traditional IRA toa Roth IRA may increase the amount of Social Security subject to income tax or possibly even what your Medicare premiums will be in two years. That’s because conversions are added to the tax calculation to determine how much of Social Security is taxable.

Your income exceeds the limits for a Roth IRA. Income limits apply to Roth IRA contributions, but not conversions. Even if you meet the requirements to open an account, you may not qualify to take full advantage of its benefits. Your ability to contribute to a Roth IRA depends on your modified adjusted gross income (MAGI) and income tax filing status.

What are some alternatives to a Roth IRA?: Roth 401(k), which is a retirement savings vehicle that is sponsored by your employer; 403(b)accounts are provided by a nonprofit or school. These plans operate similarly to 401(k)s but may have additional considerations.

Is a Roth IRA worth it?

Retirement is the biggest financial goal for most people, but many people have multiple goals. Roth IRAs have an added benefit: If you keep track of the tax basis on IRA Form 8606 when you file your tax returns each year, you can access your contributions anytime, for any reason, without tax or penalty. This is one reason why a Roth IRA can be the first place for young people to start their emergency fund.

Keep in mind, however, that there is a tax penalty if you access any earnings before age 59 1/2. You may have to pay ordinary income tax plus a 10% federal penalty tax.

There are exceptions: the earnings can be accessed penalty free, but with taxes due, for the first-time purchase of a home, qualified educational expenses or for health insurance premiums while unemployed. (per IRS Pub. 590).

A few other things you should know about Roth IRAs:

Traditional IRAs require you to withdraw required minimum distributions – a specified amount annually after a set age –regardless of how much money you actually need to pay for your expenses.

In comparison, Roth IRAs do not have RMDs for as long as you live. This arrangement provides you with flexibility in retirement to withdraw money based on your lifestyle and expense needs, instead of a set schedule. Funds are able to remain invested for longer periods of time, allowing the chance for additional investment growth through your retirement years.