If you are not currently contributing to an employer-sponsored retirement account, desire more flexibility with your investments or want to pass down a tax-free inheritance to your loved ones, you might want to look into investing through the Roth IRA.
A Roth IRA is an investment account that offers you a feasible, flexible and tax-free way to reach financial freedom, live on your own terms and even pass down an inheritance to your loved ones. You can open one at almost any financial institution.
Here’s everything you need to know about the Roth IRA:
You can invest through a Roth IRA at any age if you have earned income.
Age ain’t nothing but a number when it comes to contributing to a Roth IRA. One can be 12 or 42; however, you must be compensated from working (employed or self-employed). Kids are required to have a custodian open and manage their accounts until they reach the age of majority (18 or 21, in some states). Earned income is defined as the following: wages, salary, tips, bonuses, commission and self-employed net income. Income in the form of dividends, interest, pensions, unemployment compensation, child support or alimony does not qualify as money you can contribute to a Roth IRA.
You have more investment options.
The average 401(k) offers eight to 12 investment choices; however, an IRA allows you to choose from thousands of investments. IRAs allows more flexibility when it comes to options. Unlike 401(k)s, you are not relegated to investing in only mutual funds, index funds and annuities; you can invest in individual stocks and exchange-traded funds.
You pay lower fees.
Fees can be a dream killer when it comes to comfortably retiring. If you currently invest in your employer-sponsored account such as a 401(k), 457(b) or 403(b), it is imperative that you review two types of fees: the plan administrator fee and expense ratio. The plan administrator fee is associated with the company that operates the account, whereas the expense ratio is a fee charged based on the investment you choose. If you are unfamiliar with the above fees, you can check on your retirement account’s website or contact your employer’s human resource department. The typical 401(k) expense ratio fee is around 1 percent, although if you invest in index funds within the account, you can find lower fees. Within an IRA, an investment expense ratio fee is typically lower than 1 percent. A high expense ratio fee is anything between 0.50 to 1 percent. A great expense ratio can be found in the range of 0.05 percent to 0.10. percent, which most index funds charge.
You can withdraw your contributions tax-free and penalty-free, any time.
One of the main differences between a traditional retirement account and a Roth IRA is when you pay taxes. In a traditional retirement account, you pay taxes when you withdraw the money at retirement as opposed to a Roth, where you pay taxes up-front. Paying taxes up-front makes it possible for your investments to grow and be withdrawn tax free. Since you’ve already paid taxes, you can withdraw your contributions tax-free any time. When it comes to the interest earned on your contributions, for the most part, you’ll have to wait until you are 59 ½ years old and have had the Roth IRA account opened for at least five years to avoid paying income taxes and penalties.
You can withdraw $10,000 tax-free and penalty-free to buy your first home.
Having a 401(k) account may allow you to utilize a hardship withdrawal for college tuition, primary home repair or medical expenses; however, you will be subjected to paying income taxes and a 10 percent early-withdrawal penalty. If you’re a first-time home buyer, you can use up to $10,000 of your Roth IRA balance to pay for your primary residence without paying taxes and penalties. However, you must meet the 5-year rule—having the account opened for at least five years.
You can utilize it as an alternative to a child’s 529 plan.
Your child may not see obtaining a college degree in their future. Using a Roth IRA to fund their future dreams can be an alternative to a 529 plan. You can open a custodial account by directly contacting the brokerage company of your choice. There is much more flexibility when contributing to a Roth IRA than a 529 plan, where you are required to use the funds strictly for qualified educational expenses.
You can pass on the tax-free benefits to your beneficiaries.
Your loved ones would most definitely thank you for passing down tax-free money to them— whether it be a spouse or a child. Naming your spouse as the sole beneficiary can provide them relief if they chose to transfer the assets to an account in their name, existing or new. This can enable them to have the same tax advantage benefits as you. Designating a non-spouse (ex: child, grandchild, cousin or friend) and/or having multiple beneficiaries on the account has a different set of rules. But they too can experience tax-free distributions and avoid penalties if the rules are followed. Check in with a financial advisor to discuss the options that’ll best work in your favor.
You can convert existing retirement accounts to a Roth IRA.
Have you left a job recently, expect to be in a higher tax bracket or simply desire the flexibility of the Roth? The good news is that you can transfer your assets to a Roth IRA from your previous employer’s retirement plan or existing traditional IRA (which acts like a 401(k) outside your employer). This strategy is best for high earners who don’t qualify to directly contribute to a Roth IRA. If you wish to convert some or all your funds from a pre-taxed account to a Roth IRA, consult with a tax professional to see if the conversion is right for you as you will subjected to pay taxes.