Is There Anything Better Than a Roth IRA?
For retirees who expect to fall into higher tax brackets in retirement, Roth IRAs offer one way of avoiding taxes on investment gains while potentially deferring their payment. But this option comes with costs.
NerdWallet’s analysis lays out both sides of this equation to help you decide how best to prioritize access to income now or potential tax savings down the road.
Tax-Free Withdrawals
Roth IRAs allow tax-free withdrawals at any time due to your upfront payments that enable the IRS to view gains accumulated in these accounts as earned rather than taxed by them.
Use this feature effectively by restricting withdrawals to contributions only, not investment earnings. Withdrawals should be made according to first-in, first-out rules; any earnings you might accrue won’t be touched until withdrawals equal all the contributions you’ve made are made in full.
Self-employed workers will find this flexibility particularly valuable; their earned income may include commissions, tips, bonuses and taxable fringe benefits. But even for W-2 employees who expect their tax rates to decrease during retirement than today. Before opening an IRA account with any provider it’s also wise to inquire as to minimum account requirements, trade commissions and investment fees (commonly referred to as expense ratios).
No Required Minimum Distributions
Roth IRAs offer tax-free retirement account growth similar to pre-tax options like traditional IRAs or 401(k), yet contributions to Roth IRAs aren’t deductible like traditional or 401(k). Furthermore, these accounts don’t require minimum distributions (RMDs), meaning beneficiaries can continue taking tax-free withdrawals after their spouse passes on or the account owner passes on.
Beneficiaries of deceased Roth accounts must take RMDs as required by the IRS, otherwise penalties will apply for missed distributions. RMD amounts are calculated based on life expectancy tables such as Uniform Lifetime Table. Investors are strongly encouraged to open Roth IRAs early as additional compounding and growth may help compensate for tax bills later. Fidelity offers low fees with minimal requirements including helpful customer representatives as well as no trading commissions for stocks, ETFs and mutual funds – offering investors plenty of upside potential!
More Flexibility
Withdrawals allow time for savings accounts to grow into sizeable ones; over 10 years this compounding effect could turn an initial investment of $100k into $250K and over 20 years to $775K according to TBS Retirement Planning.
No matter your investment approach, many banks, brokerages and robo-advisors provide Roth IRA accounts. When selecting a provider it’s important to take note of their minimum account size requirements, trading commission fees and investment fee structure for funds available from that particular provider.
Make a list of your goals for investing, risk tolerance, and the savings goals and tracking tools like Empower Personal Dashboard that you would like to set and track progress toward them. Set an annual reminder to review and adjust as necessary so you stay on the path toward meeting them, and start saving as much money as possible – even if that means setting aside $100 monthly.
No Upfront Tax Break
As opposed to a traditional IRA, contributions made to a Roth will not provide an upfront tax deduction. While this might be less of an issue for people expecting lower tax brackets when they retire, for others this could prove disadvantageous.
Tax-deferred retirement accounts such as Roth IRAs offer ways to minimize taxes in retirement. One key strategy is avoiding withdrawing investment earnings before age 59 1/2 as this may trigger income taxes.
If you decide to invest in a Roth, choose an online broker with excellent customer service, low fees and an extensive selection of investments – no-load mutual funds included – like NerdWallet recommends. Our top brokers feature great education tools for new investors with low commissions on stock and ETF trades as well as reasonable account minimums. Or try Betterment which provides automated investment portfolio creation based on your future income needs and risk tolerance at an extremely reasonable fee – much less than what might be charged by human advisors!
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