One of the easiest ways to start saving for retirement is through a Roth IRA, and some would say it’s the smartest move a beginner saver can make. A Roth IRA could be a better choice than a 401(k) or a traditional IRA for a few key reasons.
Roth IRA: A Primer
A Roth IRA is an individual retirement account (IRA) that permits qualified withdrawals on a tax-free basis provided specific conditions are reached. The greatest distinction between a Roth IRA and a traditional IRA is that Roth IRAs are funded with after-tax dollars. While the contributions are not tax-deductible, this account offers tax-free growth and tax-free withdrawals in retirement. As long as you have owned your Roth IRA account for 5 years and you’re age 59 ½ or older, you are allowed to withdraw your money without owing federal taxes. In 2021, you can contribute up to $6,000 to a Roth IRA ($7,000 if you are age 50 or older and eligible for catch-up contributions). This is lower than the limit for a 401(k) but it’s still a sizable amount to help keep you on track for a secure retirement.
Roth IRA Advantages
- No RMDs. Unlike 401(k)s and traditional IRAs, which are subject to required minimum distribution (RMD) withdrawals after age 72 (and penalties if you fail to make the withdrawals), there are no RMDs with Roth IRAs, so you can withdraw funds on your own schedule.
- No time limit. You may invest money into your account for as many years as you have earned income that qualifies. This includes wages, salaries, commissions, and bonuses from an employer. If you are self-employed or in a business partnership, this would include net earnings from your business, less any deduction authorized for contributions made to retirement plans on the individual’s behalf and further reduced by 50% of the individual’s self-employment taxes. Funds pertaining to divorce, such as alimony, child support, or in a settlement, may also be contributed.
- No employer-plan restrictions. Regardless of whether you are covered by an employer’s retirement plan, such as a 401(k), you are still eligible to contribute the maximum annual amount to a Roth IRA as long as you don’t exceed the IRS’s income limits. For 2021, those with modified adjusted gross incomes (MAGI) below $140,000 (single filers) or $208,000 (married filing jointly) are eligible.
- No Impact on Social Security. Whereas distributions from a 401(k) or traditional IRA contribute to determining if your Social Security benefits are taxed (that happens once income hits a certain limit), Roth IRA distributions do not. This means that your Roth IRA withdrawals will never affect your Social Security checks.
- No taxes for heirs. You may pass your Roth IRA on to your beneficiaries, and their withdrawals will be tax-free. (If you inherit a Roth IRA, you are required to take RMDs, but they are tax-free as long as the original account owner held the account for at least 5 years.)
Before You Invest in a Roth IRA
An important element to keep in mind is the 401(k) match. If your employer matches 401(k) contributions, make sure you take full advantage of this free investment money before investing in a Roth IRA.