There are few options for investment that are looked upon so strongly by the retirement community as the Roth IRA. Financial advisors, brokers and others have heralded the Roth IRA for years—ever since it was first introduced in 1997. While many people are familiar with a traditional IRA or gold IRA, the Roth individual retirement plan differs in ways that are very important to note.
Interested in setting up an IRA, yet not sure which option is right for you? Here are a few things to understand about Roth IRAs and the pros/cons of setting up this type of retirement account.
What is a Roth IRA?
Put simply, the Roth IRA is a type of individual retirement account that is special in the fact that it’s tax-advantaged. In other words, contributions to the account are made after taxes, which is then set to earn tax-free interest. You don’t walk away with an initial tax benefit, both withdrawals during retirement can be made without paying any income tax—a major reason why the Roth version of individual retirement accounts is so well-respected.
It’s important to note that a Roth IRA isn’t really an investment in and of itself. Rather, it’s an account that holds investments. A Roth IRA will typically be opened at a brokerage, at which point assets such as stocks, bonds and mutual funds become investment options.
The Pros of a Roth IRA
At this point, it’s probably clear that Roth IRAs come along with a number of “pros (or benefits) that are more than worth focusing on—here are a few of the most important to highlight.
1) Tax-Free Compounding Interest
Perhaps the most shining example of why setting up a Roth IRA is a wise idea is due to the tax-free compounding interest associated with this type of account. What does this mean? Withdrawals throughout retirement are not subject to taxes, regardless of how much interest your money has compounded. If, say, a contribution of $50,000 to your Roth IRA builds to become closer to $500,000 by the time you make a withdrawal, not a penny in taxes need be paid.
2) Wide Variety of Investment Options
With a Roth IRA, you have a number of different types of investment options at your disposal. 401(k) plans can be great in many circumstances, but their associated investment options tend to be quite limited - not the case with a Roth IRA.
3) No Maximum Contribution Age
Another major benefit to holding your assets in a Roth IRA is the fact that there is no associated contribution age to worry about. With a traditional IRA, contributions must stop once you’ve reached 70.5 years in age. This is true even for those who are still working and earning income. A wonderful aspect of the Roth IRA is that contributions can continue to be made for many years after retirement age, with no maximums to worry about.
The Cons of a Roth IRA
The Roth IRA may seem like a perfect option for anyone attempting to build toward a comfortable retirement, and in many ways, it is. Still, there are some negative aspects of this type of IRA that may turn certain people away - take the following, for example.
1) Not Suitable for High-Income Individuals
Likely the biggest “problem” associated with Roth IRA accounts is that certain people simply aren’t allowed to make contributions — namely, individuals who bring in a large income each year. Though there is a “backdoor” method of making contributions for those who earn, say, $100,000 or more per year, high-income individuals will typically be better suited for a traditional IRA.
2) No Up-Front Tax Deduction
Another reason why many people might move in the opposite direction from a Roth IRA is the fact that these types of accounts are not associated with immediate tax deductions—traditional IRAs are a different story. The upside is that tax-free withdrawals throughout retirement make Roth IRAs appealing, however.
3) Tax Bracket Change Can Occur
If you’re currently in a higher tax bracket than you anticipate being in once you entire retirement age, a traditional IRA will likely be a better choice for you. On the other hand, those who are in a lower tax bracket than they think they’ll end up in should consider a Roth IRA. This is a common point of confusion, yet very important to take into consideration when choosing between different types of accounts.
The Bottom Line
At the end of the day, many people are going to find that a Roth IRA is one of the best options available for planning for retirement. It allows you to hold numerous types of investments without suffering tax penalties for making withdrawals throughout retirement.
Plus, you can continue to make contributions for as long as you live, even if you’re simply making residual income in one way or another. Though perhaps not the most advisable option for high-income individuals, this type of IRA is certainly worth taking a closer look at.
For best results, work with a trusted financial advisor who can walk you through the steps of setting up or rolling over an IRA account, and getting the most out of this incredibly versatile individual retirement account.