You have a lot of options when it comes to saving for retirement. Many people have access to a 401(k) through their job and an increasing number of workers are stashing retirement savings in health savings accounts (HSAs) as well. And then there are always traditional and Roth IRAs. With so many choices, it can be difficult to know which is the best place for your money.
It's often best to review the pros and cons of each retirement account available to you before choosing one. Each of the accounts listed above has some unique advantages, but Roth IRAs have some especially valuable perks. Here are three reasons you may want to consider opening one if you haven't already.
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1. You can withdraw contributions tax-free at any age
The government charges you a 10% early withdrawal penalty for taking money out of most retirement accounts before the age of 59 1/2. There are exceptions if you're paying for things like large medical or higher education expenses, but if one of these don't apply, the IRS will punish you for your withdrawal.
Roth accounts are a little less restrictive than most other retirement accounts, though. Since you fund the account with after-tax dollars -- money you've already paid taxes on -- you can withdraw your contributions tax- and penalty-free at any age. However, you could still face penalties if you attempt to withdraw your earnings before you turn 59 1/2.
It's usually not a good idea to withdraw Roth IRA contributions early if you can avoid it because this will slow the growth of your savings. But if you're really in a pinch, this could be one of the quickest and easiest ways to get the cash you need.
2. All of your withdrawals are tax-free in retirement
As previously mentioned, you fund Roth IRAs with after-tax dollars. This means you pay taxes on your contributions in the year you make them. This is different from tax-deferred accounts, like most 401(k)s or traditional IRAs, which give you an up-front tax break but require you to pay taxes on your contributions and earnings when you take the money out.
Having Roth savings can reduce your retirement tax bill because the government will essentially treat these withdrawals as if they didn't happen when calculating your tax liability. However, you must have had your Roth IRA for at least five years if you hope to withdraw your earnings tax-free.
Of course, if you go this route, you're passing up on a tax break today, so that's something you need to weigh. For some, it might just mean a smaller tax refund while for others, it could lead to a tax bill. If you don't think you can afford the increased tax burden today, you might be better off saving in a tax-deferred account instead.
3. You won't have to take required minimum distributions
In addition to deciding when you can withdraw retirement savings tax-free, the government also dictates when you have to take money out of your retirement accounts. It mandates annual withdrawals, known as required minimum distributions (RMDs), beginning in the year you turn 73. These withdrawals could raise your tax bill, but you'll face steep penalties if you don't take them.
Fortunately for Roth IRA savers, these accounts are exempt from RMDs because you already paid taxes on your money when you made your contributions. So the government lets you leave your savings there as long as you'd like. You can hold onto your money until you're ready to spend it or even pass it along as a gift to your heirs if you don't think you'll use it all.
How to get the most out of your Roth IRA
You can open a Roth IRA with just about any broker if you don't already have one. If you already have a traditional IRA or a taxable brokerage account, you may prefer to work with the same company for simplicity's sake. Otherwise, compare a few options and look at their investment options and fees to determine which is the best fit for you.
You can typically contribute up to $6,500 to a Roth IRA in 2023 if you're under 50 or $7,500 if you're 50 or older. But high earners may not be able to contribute quite as much due to the Roth IRA's income limits. If you run into these but you still want to fund a Roth IRA, you can always do a backdoor Roth IRA instead.
Only you can decide if a Roth IRA is the right fit for your money right now. If it's not, you still have plenty of other options. When you review your retirement plan annually, remember to take a look at all the accounts available to you to ensure you're not missing out on a better home for your savings.
