Monday , 11 December 2023

Roth IRA: 4 Benefits In Addition To Just Saving For Retirement

You hear a lot about how great a Roth IRA is for saving for your retirement – after all, who wouldn’t want their money to grow tax-free and be able to withdraw it tax-free too – but there are some additional benefits to investing in a Roth IRA that exceeds just saving for retirement…[and this article] highlights 4…


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#1. Emergency Fund

Many people use a savings account at a bank for their emergency cash and there is a good reason for this. When you put your money into a bank account, it is protected from losing value so if you have $5,000 saved in an account, you will always have this amount, unless you spend it but the problem with a savings account is interest rates. Even if you use a high yield online bank, chances are you aren’t keeping up with inflation…

If you want to invest your emergency fund, the best vehicle to use is a Roth IRA. Why is this? Your contributions will grow tax-free and you can withdraw your contributions at any time, tax-free. Let’s look at both of these in more detail.

  1. The money invested in the Roth IRA will grow tax-free. This means any interest or dividends you earn won’t be taxed. This is a huge advantage over putting your emergency fund in a taxable investment account where you will be paying taxes on dividends and interest as you earn them.
  2. Also, you contribute money into a Roth IRA after tax so there is no tax that needs to be paid if you take this money out. You already paid the tax.

The key here is taking out the amount you contributed for emergencies. So if your air conditioning repair bill is $3,000 and you put $1,000 into your Roth IRA, you can only take out $1,000 even if that account is valued at $2,000. That other $1,000 is earnings and you cannot take that money out now without paying a penalty.

#2. Buying A Home

If you are a first-time homebuyer, you can use the money in your Roth IRA to help with your down payment. The nice thing here is that you can take out both contributions and earnings, tax-free.

Of course, you have to meet some criteria first.

  1. The Roth IRA has to have been open for at least 5 years.
  2. Second, you can only take out up to $10,000 in investment earnings tax-free.

As with using your Roth IRA as an emergency fund, you can withdraw any amount of contributions you want so, if you saved $25,000 in your Roth and have an additional $10,000 in earnings, you could take out the entire amount, tax-free to buy your first home.

#3. Higher Education

You can use a Roth IRA to pay for qualified educational expenses too. Just like with using the account as an emergency fund, you can withdraw your earnings tax-free to pay for college – but why would you use a Roth IRA over a 529 plan to pay for college?

  • The biggest benefit is more freedom. Let’s say your child decides to not attend college. If they have money in a 529 plan, it will get taxed as ordinary income and incur a 10% penalty when they withdraw it since it isn’t being used for college expenses
  • but with a Roth IRA, you can leave any unused money in the account and use it for retirement income one day.

Another great option with a Roth IRA is setting one up for you and your child. Any income your child earns, can be invested in a Roth IRA and used to help pay for college. This helps to get past the lower contribution limits of a Roth IRA.

#4. Pass Money To Heirs

Finally, one of the best-overlooked benefits of a Roth IRA is the ability to pass it along to your heirs. No other retirement account gives you this option.

Here is what I mean by this. Let’s say you have $500,000 in your Roth IRA and you don’t need the money. You can let it grow tax-free and name your grandchild as beneficiary. When you pass away, they inherit the money. With a traditional IRA or a 401k, you don’t have this option.

  1. First, both of these accounts require you to start taking distributions once you reach age 70 ½ years old. This is regardless if you need the money or not.
  2. Second, if you do pass either of these accounts on to your heirs, they are then required to start taking distributions from the accounts. Either way, the IRS forces you to take distributions so it can collect its share in taxes.

Final Thoughts

The above are 4 great benefits to investing in a Roth IRA in addition to the great benefit of simply using this account for retirement savings. The key is to make sure you have a plan for what the money is to be used for. You can’t plan for the money to be used to fund your retirement and then suddenly start withdrawing the money to buy a house. Set a goal for the money and stick with it. This way you ensure you reach whatever goals you do set for yourself.

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