Like all IRAs, Roth IRAs allow you to potentially grow your savings through investments and get specific tax benefits. Because the income you contribute to a Roth IRA is taxed up front, there's no immediate tax break. But the money you contribute and any potential earnings you make on that money can grow tax-free.
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.
Roth IRAs can be an attractive choice for your retirement savings if your current tax rate is lower today than it will likely be in retirement. 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," explained 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 your savings continue to grow and you earn a return on your investments."
Other potential benefits of a Roth IRA
Though Roth IRAs don't offer a tax deduction up front, they can provide other benefits beyond tax-free growth and withdrawals:
- No restriction on withdrawals of contributions: You can withdrawal your contributions tax- and penalty-free at any time from a Roth account.
- 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 73 (75 if you were born in 1960 or later).
- No taxes for your heirs: If you pass your Roth IRA on to your heirs, they can generally withdraw the money tax-free as long as they follow the IRS distribution rules.
Bottom line on 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 trade-off 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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Withdrawals from an IRA prior to age 59½ may be subject to a 10% Federal tax penalty. For a Roth IRA, tax-free withdrawals of earnings are permitted five years after first contribution creating account. Earnings withdrawn prior to that may be subject to ordinary income 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 his or her 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.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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.
Supporting documentation for any claims or statistical information is available upon request.