Back in the day, workers got a corporate pension, which was given to them. You would log your years as an employee and ride off into the sunset with a cushy retirement nest egg. But times have changed; today, the onus for building a sufficient nest egg falls on the employees.
Most people associate the 401(k) with retirement. After all, roughly six in 10 employers offer one. They do have some benefits, including the fact that some employers that will match contributions up to a certain amount.
However, the popular road isn't always the best one. Consider a Roth IRA to jump-start your retirement saving before going all-in on your 401(k). It's a financial Swiss Army knife with features that make it a no-brainer. Here is what you need to know.
How does a Roth IRA work?
The Roth IRA is relatively new among investment accounts; it was created in 1998 to help Americans save for retirement. It comes with contribution and income limitations to restrict access to the middle and lower classes. You can only invest up to $6,500 annually until turning 50, after which someone can invest an additional $1,000. Additionally, income limits begin at $138,000 and start phasing out your contribution amount depending on your tax status.
Don't worry if you're a high earner; you're not entirely left in the cold. There are some workarounds for a Roth IRA's income limits, including the backdoor Roth strategy. In other words, high earners can convert tax-deferred accounts into a Roth IRA if they're willing to deal with a potential tax hit as converted funds are usually considered taxable income for that year.
Make sure you fully understand the mechanics of each retirement account you are considering, and ensure it's appropriate for your situation. Don't be shy about consulting a financial advisor to be sure.
Why investors should consider a Roth IRA
Now that we've gone through the basics of a Roth IRA, here are my top reasons why I'd argue it's the best retirement account out there:
1. Pay your taxes now, not later
The fact that investors contribute take-home money to a Roth IRA is arguably the most critical aspect of this account, yet too many people still overlook it. When you contribute to your 401(k), that money is tax deferred. That means you deduct it from your taxable income yearly when you file your taxes. It provides up-front tax savings, but you pay taxes on everything withdrawn from your 401(k) once you retire.
The Roth IRA is the opposite. You put in funds from your take-home pay and don't receive any deductions over the years. But the sweet part is that you don't pay any taxes on the money you withdraw in retirement. In other words, you're withdrawing not only your contributions later on but also all of your investment earnings tax-free. That's tremendous tax savings if your investments grow a lot over the years.
2. Superior investment flexibility
With 401(k)s, investors don't get a ton of investment options. For example, employees might go through their 401(k) information and see they must choose among broad investments like large-cap, medium-cap, or international. There might also be automated investments that you pick according to your expected retirement year.
These tools are fine, but they give investors almost no choice. Investors can't typically pick individual stocks or bonds in a 401(k), but they can in a Roth IRA. Roth IRAs are far more flexible, giving investors a choice to invest in virtually any stock or bond, and they can do so based on their specific investment goals.
3. Growth and dividend investors, rejoice!
Hypothetically, consider a few different investment strategies. For example, imagine you build a portfolio of growth stocks that generate substantial investment returns over the years. Not only will investors be sheltered from taxes on those capital gains, but achieving that wouldn't have been possible in the first place, since 401(k)s restrict investors to cookie-cutter investment choices.
Are you a dividend investor? Rather than pay taxes on their annual dividend income, investors can hold dividend stocks inside a Roth IRA and avoid all the taxes that would otherwise result from their dividend payments. A Roth IRA can be a great place to stow away some high-yield dividend stocks without worrying about a tax bill. The flexibility and tax benefits of a Roth IRA make it an excellent first step in building your retirement nest egg.
