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The Best Way to Save for Nearly Anything

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Don't let the name fool you. Even though a Roth IRA was designed as a way to help you save for retirement, you don't have to use it that way. In fact, when it comes to Roth IRAs, you have a lot of choices -- even ones that aren't available with traditional IRAs.

Great features for your savings
The design of the Roth IRA makes it an ideal place for investors to put their long-term savings. For as long as you hold the account, you'll never pay any taxes on the income you earn within the Roth. And as long as you meet the requirements for distributions, you won't pay any taxes when you take withdrawals, either. That can give young adults 60 years or more of tax-free growth -- which even at modest returns of 8% is enough to multiply your investment a hundredfold.

But if you're like many people, you might be antsy about locking your hard-earned money away for a goal that's decades away. When times are tough, you want to make sure you can get to your money for more immediate purposes, such as paying for college, buying a home, or covering medical expenses. And ideally, you'd like to avoid any taxes or penalties that may result.

However, Roth IRAs shine here also. Although you'd obviously prefer not to make withdrawals, Roth IRAs still let you get at your money.

Five years to financial security
With Roth IRAs, the key to understanding withdrawals is the five-year rule. During the first five years after you open a Roth, any money you take out will be subject to a 10% penalty, and you'll also have to pay tax on any earnings you take out.

After the first five years, however, you have a lot more flexibility, even if you're nowhere near the usual age 59 1/2 cutoff for taking money out of an IRA penalty-free:

  • You can take out the original contribution amount to your Roth IRA without paying tax or a penalty, regardless of what you want to use it for. So for example, if you've put in $5,000 and it's since grown to $10,000, you can take out up to $5,000 free of tax or penalty.
  • You can avoid penalties on up to $10,000 spent to buy a new home, if you qualify as a "first-time homebuyer" for IRS purposes.
  • If you're disabled, you don't have to pay penalties on withdrawals.
  • You may be able to pay health insurance premiums if you've lost your job, or substantial medical expenses, without penalty.
  • Money used toward college tuition and other qualified higher education expenses don't get penalized.

Of course, all of these penalty exceptions have rules, so be sure to make sure you actually qualify. But the idea behind them is simple: If you foresee potentially needing money toward these non-retirement goals, there are ways you can get at least some of it out of a Roth without paying taxes or penalties. So you can put money in a Roth and not worry so much about whether you'll be able to get to it if you need it.

Investing smart
Obviously, the potential to use money sooner than later may change your investment philosophy for your Roth. Typically, high-growth stocks such as Dolby Labs (NYSE: DLB  ) and Marvel Entertainment (NYSE: MVL  ) make great investments in a Roth, because you maximize the amount of tax-free growth.

But with a time horizon of 10 years or less -- which might apply to buying a home or paying for college -- more conservative investments may make more sense. They may not have as much growth potential, but a combination of attractive valuations and dividend payouts can round out your Roth portfolio well. Here are a few examples:

Stock

Current P/E

Current Dividend Yield

BP (NYSE: BP  )

5.9

8.5%

Novartis (NYSE: NVS  )

10.2

4.7%

Raytheon (NYSE: RTN  )

9.8

3.2%

Tidewater (NYSE: TDW  )

5.0

2.7%

Illinois Tool Works (NYSE: ITW  )

10.4

4.1%

Source: Yahoo! Finance. As of March 30.

Do it today
With all of those options, opening a Roth IRA makes a lot of sense. But you have only another two weeks to do so for 2008, so don't wait. Get started on your path to financial security today and get the five-year clock rolling to have more flexibility with your investments.

For more on IRAs and other savings tips:

The Fool's Rule Your Retirement newsletter service focuses on the best ways to save for long-term goals. Get a free 30-day trial today and see how you can improve your portfolio.

Frustrated with your 401(k)? Even if your employer's plan isn't the greatest, you don't have to give up your dreams of a happy retirement. Get the tips you need to turn your retirement savings around in our special report, "How to Make The Most of Your 401(k)" -- just click here for instant free access.

Fool contributor Dan Caplinger opened his first Roth IRA in 1996. He doesn't own shares of the companies mentioned above. Novartis is a Motley Fool Global Gains pick. Dolby Laboratories and Marvel Entertainment are Motley Fool Stock Advisor recommendations. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy bends like a ballerina but never breaks.


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  • Report this Comment On January 11, 2011, at 4:52 AM, Johnexo wrote:

    No matter how the economy is working, it is very important to save money. Saving doesn't always mean sacrificing. You still have to enjoy your life in the present to stay happy in the future. Saving money is on going process and if one can strike a proper balance between income and expenses, saving will be fun than burden.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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10/22/2014 4:00 PM
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