There's a reason working Americans today have to save for retirement. Not only is it very difficult to live on just Social Security, but the program is looking at potential benefit cuts that may reduce those monthly payments substantially. It's important to build a retirement nest egg so you're not overly reliant on a program whose future is somewhat uncertain.
And remember, even without benefit cuts, Social Security may only replace about 40% of your paycheck, assuming you earn an average wage. Most retirees need a lot more income than that to keep up with their expenses and have money left over to enjoy life. So it's important to have savings outside to supplement your Social Security benefits.
Image source: Getty Images.
Now when it comes to building a retirement nest egg, you have choices. Many people opt to fund a traditional IRA because these accounts give you a tax break on the money you contribute.
A Roth IRA does not. And some people may feel that they need that up-front tax break more than the other benefits a Roth IRA has to offer.
But the perks that come with a Roth IRA could easily outweigh the fact that contributions are made with after-tax dollars. Here are four benefits that make the case for saying yes to a Roth IRA.
1. Tax-free growth
The IRS has an annoying way of getting its hands on all of your income. Earned $1,200 from a side hustle? The IRS gets a piece. Made money in your brokerage account? That's taxable, too.
While a Roth IRA may not give you a tax break on contributions, investment gains in your account are yours to enjoy tax-free. So if you contribute $10,000 that grows into $110,000 over time, you could walk away having gained $100,000 without the IRS getting a penny of it.
2. Tax-free withdrawals
Managing your money can be a bit more stressful in retirement than during your working years, namely because you're living off of savings. Another nice thing about Roth IRAs is that they come with tax-free withdrawals. That could make it a lot easier to budget at a time when you're looking to be cautious.
Also, we don't know what tax rates are going to look like 10, 20, or 30 years from now. But they may not be as favorable as they are today. If you have a Roth IRA, you won't have to worry about your tax rate rising -- at least not in the context of retirement plan withdrawals.
3. No RMDs
If you save for retirement in a traditional IRA, you can't just leave your money to sit and grow indefinitely. At a certain point, you'll be on the hook for required minimum distributions (RMDs).
RMDs are a pain for a couple of reasons. First, they force you to take money out of your tax-advantaged savings, so you lose out on tax-advantaged growth. Secondly, they count as income. Even if you don't need the money, if you're on the hook for a $5,000 RMD, that's $5,000 the IRS will tax you on.
Roth IRAs do not impose RMDs, so you don't have to worry about any of this.
4. More flexibility in a pinch
Because Roth IRAs are funded with after-tax dollars, the IRS is lot more lenient about early withdrawals. With a traditional IRA, any sum you remove before turning 59 and 1/2 is subject to a 10% early withdrawal penalty unless you qualify for a limited exception.
With a Roth IRA, you can withdraw your principal contributions at any age without a penalty, since you never got a tax break on that money in the first place. It's only the gains portion of a Roth IRA that you have to worry about tapping early.
Now that said, do keep in mind that the purpose of a Roth IRA is to house the money you're saving for retirement. If you keep hitting up your Roth IRA to cover emergency expenses or other bills, you risk having a serious shortfall on your hands once retirement actually arrives.
However, if you're truly in a pinch, you can use a Roth IRA to bail yourself out with the understanding that you should try to avoid early withdrawals at all costs.
There are plenty of things to love about Roth IRAs. So even though you won't get a tax break on the money that goes into one, it very much pays to fund a Roth IRA consistently in the course of building retirement savings.
