Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)
Like all IRAs, Roth IRAs allow you to potentially grow your savings through investments and get specific tax benefits. Since the income you contribute to a Roth IRA account is taxed up front, there’s no immediate tax break. But the money you contribute and any earnings you make on that money can grow tax-free.
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Tax-free withdrawals
With a Roth IRA, you can withdraw your contributions at any time with no additional tax or penalty. After age 59 ½, you can also withdraw any earnings you’ve made with no tax or penalty, as long as you’ve held the account for at least five years.
The benefit of paying taxes up front makes Roth IRAs an attractive option for retirement savings, especially if you expect to be in a higher tax bracket when you retire. On the other hand, if you need a tax deduction now or plan to be in a lower tax bracket when you retire, a traditional IRA could make more sense.
"Many investors choose a Roth IRA because they'd rather pay taxes now and avoid owing additional taxes when they take their money out for retirement," says Hayden Adams, CPA, CFP®, and director of tax planning at the Schwab Center for Financial Research.
"When you look at it that way, the potential tax savings of a Roth IRA can be fairly significant, assuming you continue to grow your savings and earn a return on your investments."
Other benefits of a Roth IRA
A Roth IRA also provides other benefits beyond tax-free growth and withdrawals:
- No age restrictions: You can contribute at any age, if you have earned income and your modified adjusted gross income (MAGI) falls within the IRS limits.
- No required minimum distributions (RMDs): Unlike most retirement savings accounts, Roth IRAs are not subject to required minimum distributions (RMDs)—withdrawals the IRS requires you to take each year, starting at age 72.
- No taxes for your heirs: If you pass your Roth IRA onto your heirs, they can generally withdraw the money tax-free as long as they follow IRS distribution rules.
Summing up Roth IRAs
Roth IRAs are a useful retirement savings tool that can help you set money aside for potential growth. In addition to potentially boosting your retirement savings, they can provide greater flexibility for you and your heirs because of their unique tax rules. The tradeoff is that you won’t receive any near-term tax benefit. But you can look forward to potential tax savings in retirement.
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Roth IRA earnings can be withdrawn tax-free after age 59½, if you’ve held the account for at least five years. If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and a 10% federal tax penalty.
Investing involves risk, including loss of principal.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for their own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, you should consult with a qualified tax advisor, CPA, financial planner, or investment manager.
The Schwab Center for Financial Research is a division of Charles Schwab & Company, Inc.
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