Contributing to a Roth IRA is more tax-efficient than simply investing in a taxable brokerage account. The money in the Roth IRA accumulates tax-free and all contributions and earnings can be withdrawn tax-free once you've kept your Roth IRA open for more than five years. There is another reason to protect yourself from a Roth and it relates to access to income now and potential tax savings in the future. A Roth can take away more income in the short term because you are forced to contribute money after taxes.
With a traditional IRA or 401 (k), on the other hand, the income required to contribute the same maximum amount to the account would be lower, since the account is based on pre-tax income. For most of us, securing the opportunity to retire means investing a portion of our income in an IRA, 401 (k), or both, for many years. These retirement accounts offer tax relief by not paying taxes on your deposits (which can give your savings greater potential for growth). But later on, you'll have to pay income tax when you withdraw money from these accounts after you retire.
This is an IRS-approved strategy that allows people with high incomes to access the benefits of Roth IRA accounts, which we'll detail later. In addition to the differences described above, traditional IRAs and Roth IRAs share a number of common characteristics. A Roth IRA can work as a backup account if you save for things beyond retirement, whether for an emergency fund or for future education expenses. You need a turnaround time with a Roth IRA because the IRS requires you to open and deposit funds into a Roth account at least five years before withdrawing it when you retire.
In the family of financial planning products, the Roth Individual Retirement Account (IRA) sometimes resembles the great younger sister of the traditional IRA. If you don't name a beneficiary, your spouse (if he is your primary beneficiary) can choose to inherit your Roth IRA or transfer it to a Roth IRA in your name. Since a Roth IRA account is funded with dollars you've already paid income taxes on, you can withdraw contributions without taxes or penalties at any time. A traditional IRA is your only option if you don't qualify for a Roth IRA due to income restrictions.
The retirement rules of Roth IRAs are more flexible than those of traditional IRAs and employer-sponsored plans, such as 401 (k), etc. If income thresholds make direct contributions to the Roth IRA impossible, you can always opt for a clandestine conversion to the Roth IRA. You can avoid the 10% penalty for early withdrawals from a traditional IRA or early withdrawals of earnings from a Roth IRA by following a short list of IRS-approved purposes. But before you open an account, you should understand the differences between a Roth IRA and a traditional IRA.
While the best time to open a Roth IRA is when you're young and you have the magic of capitalization and interest on your side, it can also be a useful vehicle when you're older and want to deposit funds into an account that isn't subject to the minimum distribution rules required during the participant's lifetime. Since I'm not particularly interested in recognizing the benefits of a Roth IRA today, I have a hard time overcoming how fussy the Roth IRA is. This means that you can't take full advantage of both a traditional IRA and a Roth IRA, although you can contribute to each type of account for a given year.