Arguably the most significant benefit of a Roth IRA is the earnings grow tax-free. As a result of not having to pay taxes along the way, your future earnings can compound. This further bolsters account growth for several years, if not decades.
Other investment accounts, such as a 401(k) or Traditional IRA, grow tax-deferred. This means you will eventually be forced to pay taxes on those earnings at a later date.
2) Tax-Free Withdrawals
Once you turn 59½, you can withdraw from your Roth IRA tax-free, provided the account has been established for at least five years. This is extremely valuable for Roth IRA owners who started contributing early in their careers. How so? Due to the power of compounding I just mentioned, you are able to bypass paying income taxes on the large investment gains accumulated over time.
This is not the case for tax-deferred investment accounts. Once you reach retirement and start taking withdrawals, you must pay income taxes on both your original contributions and the earnings.
3) No RMDs
Required Minimum Distributions (RMDs) are annual amounts that the IRS requires you to withdraw from tax-deferred accounts. Once you turn 72, you must withdraw a certain amount each year and pay taxes on that amount until the account balance effectively reaches zero. This is essentially the government telling you to “pay up” after shielding your tax-deferred investments from taxes for so long.
RMDs do not apply to Roth IRAs, which means you have the ultimate flexibility on deciding when you want to withdraw funds and how much you wish to withdraw during retirement.
How Much Can You Contribute?
Roth IRA owners younger than age 50 can contribute up to $6,000 for the calendar year 2020. If you are age 50 or older, you can contribute up to $7,000.
Although several vehicles can help you reach your retirement goals, the Roth IRA is one-of-a-kind given the nature of its tax-free growth. If you already contribute to your company plan at work and are looking to save more for retirement, I strongly recommend a Roth IRA to diversify your investments.
