The 8 Best Reasons to Invest in a Roth IRA

by Christian Hudspeth

This article was updated on June 3, 2019.

When it comes to the family of retirement accounts, the Roth IRA is an investor favorite -- and for good reason.

A Roth IRA is a tax-advantaged account that you can use to save money for retirement. But unlike bank accounts, which simply hold the cash you deposit, Roth IRAs let you put your money in growth-oriented investments such as stocks, bonds, mutual funds or ETFs -- all of which can help you make serious headway toward that million-dollar retirement goal you've always dreamed about.

But it gets better. Because you invest after-tax money in a Roth IRA, that money -- plus any earnings -- will be left to grow over time without ever being hindered by taxes. And when it's time to retire, money you withdraw from your Roth IRA won't be taxed by the Internal Revenue Service again.

That last part alone is a huge advantage over traditional IRAs and 401(k) plans, both of which are tax-deferred plans that require you to pay federal income tax on every dollar you withdraw during retirement.

How a Roth IRA Could Save You Tens of Thousands of Dollars in Taxes

All of this means a Roth IRA is not only a great way to build a serious nest egg, but it also can save you tens of thousands of dollars in income taxes.

I'll prove my point. Say I open two retirement accounts today -- a traditional IRA and a Roth IRA -- and start investing $200 every month into stocks in each of the accounts. Assuming both accounts earn an average of 9% per year, each fund would grow to a handsome $936,264 after 40 years, according to our simple savings calculator. 

Not bad. So what's the advantage of the Roth IRA? Let's say I'm ready to retire and start making withdrawals. If I were to withdraw $50,000 each year from my traditional IRA, my effective tax rate would be somewhere around 10% to 15%, meaning I would have to pay $5,000 to $7,500 in income taxes for that withdawal. Ouch.

But if I instead chose to take money from my Roth IRA in retirement, my $50,000 per year withdrawals wouldn't be taxed at all. It's a great deal!

Now before we get too far into this, you should know there are a few IRS rules you have to meet to be eligible to open and contribute to Roth IRA. And here they are...

Roth IRA Rules and Income Limits for 2019

1. There are income limits to be eligible for a Roth IRA. If you want to contribute the maximum allowed amount to your Roth for the 2019 tax year, you must have a modified adjusted gross income (MAGI) of less than $122,000 per year ($193,000 for married joint filers and qualifying widow(er)s).

Single filers earning under $137,000 per year ($203,000 for married joint filers and qualifying widow(er)s, can still get some tax benefits from a Roth IRA, but they will be reduced or "phased out" as the IRS says. (Note: High income earners may be able to get around these income limits through a Backdoor Roth IRA).

2. You can contribute only "earned" income -- money you made from salary, wages or self-employment -- into your Roth IRA. For example, a college student who earned $2,000 from his summer job may contribute up to $2,000 into his Roth IRA.

3. You may contribute up to a maximum of $6,000 ($7,000 if you're older than 50) into your IRAs or Roth IRAs in a given tax year.

4. Before withdrawing your investment earnings, you must have the Roth IRA open for at least five tax years and be older than 59½ (that is, if you want to avoid a tax bill or getting hit with the IRS' 10% early withdrawal penalty). We talk about certain exceptions to this rule in the 5 Safe Ways to Tap Your Roth IRA Before You Retire.

(For more details on Roth IRA rules, do an online search for "IRS Roth IRA requirements.")

By now you can probably see that the Roth IRA is a stellar retirement tool. But given the different ways retirement accounts are taxed, how do you know if a Roth IRA is the right choice for you? Answer: If you fit any of these eight situations:

1. Your employer doesn't offer a 401(k) plan but you still want to invest for retirement.

Don't let the lack of a company 401(k) plan keep you from saving for retirement. A Roth IRA is a great tool for almost any working person of any age.

You can be employed for a company, a 16-year-old with a summer job, or a self-employed entrepreneur. As long as you earn your income from work and meet the requirements listed above, you can save toward retirement through a Roth IRA.

2. You want to invest in a wider selection of investment choices than your 401(k) plan offers.

With 401(k) plans, you're usually limited to investing in the few mutual funds that your employer chose, which may carry expensive fees and a lousy track record of performance. But when you open a Roth IRA through an online brokerage, you can invest in any stock, bond, ETF, option or mutual fund you want. You're also free to sell the investments that aren't working for you without triggering a taxable event as long as it's all done within the Roth IRA account.

[Need ideas on where to start? I talk about an easy way to build your own well-diversified Roth IRA portfolio of ETFs (based on my own) in The Lazy Man's Retirement Portfolio.]

3. You've maxed out your 401(k) plan contribution limit for the year but you still want to put more toward retirement.

Manage to hit your 401(k) plan's annual contribution limit of $19,000 ($25,000 for those age 50 or older in 2019)? Congratulations! That's a problem many of us wish we had. But in case you want to go for extra credit or you're just looking to catch up in building your retirement fund, look again to the Roth IRA.

The amount you can contribute to a Roth IRA is not affected by 401(k) plan contributions, so you can keep putting money into your Roth IRA up to its $6,000 ($7,000 for ages 50+) contribution max long after the 401(k) is filled up.

4. You're not in your peak earning years and you expect to have a higher annual income in retirement.

If you're working part time or expect you'll have a larger annual income in retirement, you can use the Roth IRA to take advantage of your lower tax rate situation right now.

For example, if you're currently earning $20,000 per year but you're planning to withdraw $50,000 per year in retirement, you may be best suited with a Roth IRA because you can pay taxes now while you're in a lower-income tax bracket and not have to pay income tax on withdrawals when you're in a higher tax bracket in retirement.

5. You expect income tax rates to rise in future decades.

Income tax rates are near historical lows -- even with the top tax bracket being 37% (post 2018 tax-reform). But with the federal government's rising debt and deficits, many aren't holding their breath that taxes will stay low forever.

Contributing to a Roth IRA will let you take advantage of today's low tax rates and let you take withdrawals tax-free in retirement -- no matter what happens with future income tax hikes.

6. You want to have penalty-free access to your money in case of emergencies.

While you should try to avoid raiding your retirement fund, sometimes life's unexpected events take priority. Under a 401(k) plan or traditional IRA, any early withdrawals you take out before age 59 1/2 will get slapped with federal and state income taxes plus a 10% early withdrawal penalty.

But if you have a Roth IRA, under the IRS ordering rules all of the contributions you make may be withdrawn at any time without tax or penalty. 

So if you contributed $20,000 over the years into your Roth IRA, you can take up to that amount without taxation. Just remember to leave your investment earnings in the account alone -- that part will be taxed and given the 10% penalty if you try to take it out before 59 ½. And try to avoid making too many withdrawals -- you don't want your retirement to suffer!

7. You want to leave your heirs with a tax-friendly inheritance.

Some have called the Roth IRA "the best retirement fund to die with" -- and that may not be a far-fetched statement. As long as your heirs are labeled as beneficiaries and don't touch your Roth IRA for the five-tax-year waiting period after you're gone, they may take distributions from your Roth IRA without taxation or penalty.

And if your spouse is the sole beneficiary, they may take ownership of your Roth IRA and take withdrawals any time after you're gone. In other words, die with a $1 million fortune in your Roth IRA and it won't be long before your spouse or an heir of yours becomes the next family millionaire.

8. You're older than 70 and want to keep building your nest egg.

Whether you're forced to go back to work or you don't want to quit, it's nice to know the Roth IRA lets you keep saving with tax-free growth toward retirement (or, in this case, much later retirement).

With a traditional IRA or 401(k) plan, the IRS forbids you from making contributions and requires you to start taking minimum withdrawals (called RMDs) after age 70 no matter what. But with the Roth IRA, you're never required to withdraw funds and you can keep contributing regardless of your age.

Without a doubt, the Roth IRA is one of the simplest, most flexible and universally practical retirement accounts available. There are no tax implications to worry about when you contribute (a blessing during tax time), your nest egg can grow without the headwinds of taxes and when it's time to retire you can withdraw as much or as little as you'd like.

As long as you meet all of the Roth IRA rules listed earlier (and perhaps consult your tax advisor for more information), you can how to open a Roth IRA at any online brokerage firm in as little as 20 minutes.

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