When saving for the future, there are many different account types, each having various reasons for a person to contribute to them. For your aid, here are four reasons to contribute to a Roth IRA:
1. Hedge on taxes
We cannot predict what tax rates will look like in five years let alone how they will look during retirement. Pre-tax contributions (401(k)s, IRAs) are most valuable when tax rates are lower in retirement; after-tax contributions (Roth IRAs, Roth 401(k)s) are better when taxes are higher during retirement. Because we do not know what tax rates will be in the future, both account types should be used in a proper wealth plan in order to hedge tax risk.
2. Saving for college
Unlike a Traditional IRA, Roth IRA contributions can be withdrawn at any time without incurring a tax penalty. If $25,000 has been contributed over five years than that $25,000 can be withdrawn for anything at anytime. In addition, withdrawals over the amount of contributions (growth) can be taken without penalty if those funds are used for qualified education expenses. Taxes may be applicable when gains are used for other expenditures, especially if this occurs before the age of 59 1/2. You will want to consult your CPA for more information on such actions.
3. Emergency savings
We should all have liquid cash available in case life happens, but what if a health emergency occurs that requires more money than we have in savings? In this case, Roth IRAs can serve as an emergency savings account. As explained before, all contributions can be withdrawn at any age without penalty or taxes.
4. Wealth transfer
The strategy of a wealth transfer plan depends on the recipients and what is best for them? In the case of a Roth IRA, if the inheritor is a non-spouse beneficiary, they will receive Roth IRA funds tax-free. All distributions will also be tax-free. If a Traditional IRA is inherited, the beneficiary must take distributions, which are taxable. If the beneficiary is in their 40s or 50s and making a good salary, inheriting a large tax bill is not the best scenario. If the beneficiary is a spouse, the spouse can rollover the funds into their own Roth IRA and they are not required to take distributions.
An individual can only save $5,500 in a Roth IRA(under 50 years old) each year and there are income limits designed to keep wealthy investors from storing money in this tax-free investment vehicle. These facts point to a lucrative investment tool for the middle class.
If you meet the income requirements this is one of the most flexible savings accounts available to you and should be taken advantage of.
