A Roth IRA is perhaps the most powerful retirement account you can get your money into. The combination of tax-free growth throughout your life, the ability to accept rollovers from other retirement plans, and tax-free withdrawals in retirement make it a wonderful part of your arsenal.
Just why this combination of factors is so powerful takes a little bit of explaining, but since they all work together, a Roth IRA ultimately offers incredible tax savings in retirement. Here's why.
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Tax-free growth throughout your life
Once your money is inside your Roth IRA, it can typically grow inside that account for the rest of your life, completely tax free. Unlike many other retirement accounts, Roth IRAs are not subject to required minimum distributions during the original account owner's lifetime.
That means that if you don't want or need to take the money out of your own Roth IRA, you don't have to. This helps keep your taxes down because if your stocks pay dividends or if you receive capital gains from selling them, you wouldn't pay taxes on any of that activity happening inside your Roth IRA.
It's also important because when you take those required distributions from traditional-style retirement plans, that distribution itself is typically taxable at your ordinary income tax rates. Then, any money from those distributions that you reinvest itself becomes subject to capital gains and dividend taxes. Because you are not required to take money out of your Roth IRA during your lifetime, those types of taxes don't hit your Roth IRA money.
The ability to take rollovers from other retirement plans
Speaking of those required minimum distributions, one strategy that people employ to minimize them is roll money over from other retirement plans into their Roth IRAs. While you pay taxes on those rollovers if they come from Traditional-style retirement plans, once the money is inside your Roth IRA, it can grow tax free like any other money inside that account.
While it may seem strange to willingly pay taxes now to avoid paying taxes later, there are good reasons to roll money into a Roth IRA. First, if you expect that your money will grow over time, there's a good chance that you'll be paying less in taxes by rolling it over now and then letting the remaining money grow tax free.
Second, you cannot roll over money that needs to cover your required minimum distributions -- you must take that money completely out of your retirement plans. If you're going to be forced to pay taxes on that money anyway, why not move it earlier when you can still get it rolled into your Roth IRA for that future tax-free growth?
Third, with a rollover, you can choose the timing and amount of money you move. On the flip side, with a RMD, the amounts and timing are completely determined by a formula driven by your age and account balance. That allows you the flexibility to choose to execute your rollovers when they make the most sense for you. For instance, if there's a window between when you retire and when you start drawing Social Security, that can be a great low-income time to roll your money into a Roth IRA.
Tax-free withdrawals in retirement
The other big benefit of a Roth IRA is that if you do want or need to pull money out of it, once you qualify, your withdrawals are completely tax free. Not only are they tax free, but qualifying Roth IRA withdrawals don't even count as income.
This is important, because by not even counting as income, that gives you a way to access your money without triggering income-based taxes and other costs. For instance, your Social Security benefit may be taxable based on your income, and your Medicare Part B premiums depend on your income as well .
Because of the way qualifying Roth IRA withdrawals are treated, the money you do tap in a qualifying way from your Roth IRA is some of the most efficient money you can access once you're retired. In terms of what it means to qualify, you generally need to only have reached age 59 1/2 and have had your Roth IRA opened and funded for at least five years.
Get started now to take advantage of these incredible tax benefits of Roth IRAs
With all that they have going for them, it makes sense to get money inside your Roth IRA to make the most of the retirement tax savings they offer. Recognize, though that the only ways to get money into a Roth IRA are to either directly contribute from your earned income or to roll over money from another qualifying retirement plan.
As a result, the sooner you get started saving for your retirement, the better your chances are of getting a decent balance inside your Roth IRA to make use of those benefits. So get started now, and get yourself set up to get the best of what your Roth IRA has to offer.
