In order to make the most of your retirement savings, you should consider using various tax-advantaged retirement accounts. The 401(k) heads the list for most people due to the fact that many employers match at least a portion of contributions. But once the match has been fully captured, many financial experts suggest that the next retirement dollar go into another investment vehicle with a whole host of advantages--the Roth IRA. Here are five factors that make a Roth IRA a winner:
1. Lock in today's lower tax rates. If you are looking for tax-efficient ways to invest for retirement, the Roth IRA can be a big help. With a Roth IRA, you pay taxes before you contribute. That means you pay taxes at today's rates. Your money then grows tax-free in the Roth IRA. When you take the money out during retirement, you don't have to pay taxes on it. This is a big deal if you think that taxes, or your tax bracket, will be higher down the road.
2. Access your money before retirement. A Roth IRA can be used as a sort of emergency fund. You can access the money you contribute without penalty, and without paying tax, anytime. If you withdraw your earnings prior to age 59?, you will have to pay income tax and a penalty on the earnings. However, if you only withdraw money that you have contributed, you don't have to worry about that. Plus, you can take other penalty-free withdrawals for first-time homeownership, college costs, and large unreimbursed medical costs.
You want to be careful, though. There are opportunity costs associated with taking money out of your retirement account early. For example, you will miss out on valuable compound interest over time, which is the greatest investing asset you have. By taking money out of a retirement fund you halt the compounding process.
3. No required minimum distributions. With traditional IRAs and traditional 401(k)s, you are required to take a minimum distribution from your account after the age of 70?, even if you don't need the money. These required minimum distributions (RMDs) aren't necessary with a Roth IRA. This gives you more flexibility in retirement, allowing you to choose how much you withdraw. Additionally, it gives you the chance to pass more tax-free money to your heirs through an inherited Roth IRA.
4. Variety of investments to choose from. In many cases, a company-sponsored 401(k) has limited investment choices. With a Roth IRA, you have a variety of investment choices and better control of those choices, allowing you to build the portfolio that you want. You can hold a wide variety of asset classes in a Roth IRA, and that means you can do a lot more than what might be offered through your 401(k).
5. Conversion rules. It's possible to convert your traditional IRA to a Roth IRA, no matter how much money you make. While you won't be able to make new contributions if you earn more than a certain amount, you can roll over your other retirement account to a Roth IRA. However, there are tax consequences associated with rolling a traditional account over to a Roth. Make sure you understand them, and that paying the tax now is often worth it due to tax savings later.
The Roth IRA is a flexible retirement account that provides you with a lot of options and opportunities. Consider your situation, and determine whether or not you can increase your tax-efficiency in retirement while building your nest egg with the help of a Roth IRA.
FMF writes at Free Money Finance, a personal finance site that helps readers grow their net worths. He shares practical tips that have helped him accumulate a significant net worth and can do the same for others.
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