5 Reasons to Open a Roth IRA Now

A Roth IRA is one of the best – perhaps the very best – way to save.

It’s an Individual Retirement Account (IRA) that provides tax-free income after you’ve retired and a lot of flexibility to make penalty-free withdrawals between now and then.You probably won’t be able to put all of your savings in a Roth IRA.

Contributions are limited to $5,000 a year if you’re under 50 and $6,000 a year if you’re over 50.

5 Good Reasons to Open a Roth IRA Today

Reason #1: It can double as an emergency fund.

In a perfect world, you’d never touch the money in a retirement account until your working days are over. But in these economic times people don’t often have a choice. Everything from layoffs to medical bills can put a pinch on everyone.

If you have to tap most retirement funds, it can get quite expensive. Withdraw money from a 401(k) or traditional IRA before you reach 59½, and you’ll be hit with a 10% penalty and have to pay income taxes on whatever you take out. If you need $5,000, for example, you might have to actually withdraw $6,500 because of those penalties and taxes.

That’s not the case with a Roth IRA.

You can withdraw contributions anytime, for any reason, without paying any penalties or taxes. That’s one of the reasons Mari Adam of Adam Financial Associates in Boca Raton, Fla., says that opening a Roth IRA is one of the best financial moves you can make.

If you’re like most Americans, you’re probably lacking in both your emergency and retirement savings. So if you have to play catch-up, using a Roth as part of your emergency fund lets you do both simultaneously. “It gives you the flexibility to where if you need it in an emergency or for something important, you can access the principal for any reason tax-free and penalty-free,” Adam says.

Reason #2: A Roth IRA can also help you save for college bills and a home.

In most cases, you must pay a 10% penalty and income taxes if you withdraw any earnings from a Roth IRA before you turn 59½ years old.

Note that I say most cases. There are instances where you can tap some of your earnings prior to turning 59½ without paying any penalties, taxes or both. That’s why some parents are using Roth IRAs to save for their kids’ college education. Of course, your contributions can be withdrawn at no cost whenever the money is needed.

But parents who take out all of their contributions can then tap some, or all, of their earnings and only have to pay income taxes on that early withdrawal. The 10% penalty is waived if the money is used to cover a qualified higher education expense. This includes college tuition or expenses for you, your spouse, your child or grandchild. Any money you don’t need for college costs can simply remain in your Roth IRA.

If you had chosen a 529 College Savings Plan instead, you’d have to pay a 10% penalty and income taxes on any leftover money you withdraw for noneducational expenses. You can also take up to $10,000 from your Roth IRA for a down payment on your first home without paying any taxes or penalties, even if some of that money is earnings. The only catch is that the account must have been open at least five years.

Reason #3: It’s one of the best tax breaks you’ll ever get.

The fact that the Roth IRA lets your earnings grow tax-free and be withdrawn tax-free is one of the best tax breaks Uncle Sam offers. You can’t even comprehend this until you really understand the power of compounding.

Think about it: Your money can grow for decades, and you’ll never be taxed on it.

At 59½ years old, you can start withdrawing from this jackpot when all your friends with traditional IRAs have to pay taxes on every dollar they touch. If you’re 30 years old and max out your Roth IRA to the current limit for 30 years and average an 8% return, you’ll have $608,000.

If you used the 4% rule, that would provide $24,000 a year, tax-free. If you were in the 15% tax bracket, and had to pay taxes on your withdrawals, it would be about the equivalent of $30,000 per year. Of course, contributions to Roth IRAs must be made with after-tax earnings.

This is one of the biggest differences between a traditional IRA and a Roth IRA. With a traditional IRA, contributions (up to the $5,000 limit or $6,000 if you’re over 50) can be deducted from your earnings, lowering your income tax bill for that year. But unless you’re in a higher tax bracket, you really wouldn’t see much savings with a traditional IRA anyway.

If you’re in the 25% tax bracket and contributed $5,000 to a traditional IRA this year, you could save up to $1,250 in federal income taxes. But would you actually save and invest that difference? Probably not. If you’re like the majority of Americans, it would be absorbed into your annual spending on things like dining out, clothes and cell phone bills.

With the Roth, you won’t save any money in taxes now, but you’ll be able to grow that money for decades and never pay taxes on any of it. Robert Henderson, president of Lansdowne Wealth Management in Mystic, Conn., says this is especially important considering taxes could rise in the future.

With a Roth IRA, you’re essentially paying taxes on your contributions now and protecting yourself against higher taxes in retirement. “It’s a huge advantage because you don’t even know where taxes are going to be 30 years from now,” Henderson says.

Reason #4: It can serve as a stand-alone retirement account or complement a 401(k).

If you’re self-employed or don’t have a retirement plan available at your employer, start with a Roth IRA.

Even if you have a 401(k) plan at work, it makes a lot of sense to include a Roth IRA to your retirement savings. Anyone can open a Roth IRA, even if they have a 401(k), as long as they earn less than $122,000 for single filers and $179,000 for married couples.

Reason #5: You can leave your money in a Roth IRA as long as you like.

With a traditional IRA, you must start making withdrawals by age 70½.

There is no such requirement for Roth IRAs. You’d be lucky to be in this situation, but you can hold this tax-free money indefinitely and pass it on to your heirs.