Five Reasons a Roth IRA Can Be a Powerful Tool
Let’s start with a little background. Contributions to traditional IRAs and employer-based retirement plans are usually tax deductible. Any earnings generated on those contributions can be re-invested with income taxes deferred. When withdrawals are made in retirement, the money drawn from these accounts will be taxed as ordinary income. On the other hand, contributions to a Roth IRA are not tax deductible. The earnings grow tax-free, and, if you follow the rules, 100% of future withdrawals (your original contributions plus earnings) are not taxed. That’s a pretty powerful reason to consider this financial tool, but here are five more:
Earnings are Tax-free: Yes, I know I just mentioned it, but something this good has to be said twice! Of course, you must follow certain rules. You have to hold the Roth account for at least five years and be at least age 59½ before you draw the Roth’s earnings to avoid potential penalties and taxes (there are, however, certain exceptions, like death, disability, higher education, etc.).
No Required Minimum Distributions (RMDs): Once you turn age 70½, current income tax rules say you must take withdrawals from traditional IRAs and retirement plans. The percentage starts at about 3.5% of the total value of all your plans and then increases each year. (Of course, the escalating withdrawal rate is intended to get more 1099-reported income on your tax return.) The Roth IRA does not have an RMD and can continue to accumulate until the latter of these two events: your death or that of your spouse.
Excellent Inheritance: Properly structured, your Roth IRA can be left as an “Inherited Roth IRA” to your heir(s) who can then roll it over tax-free. Each heir can choose to either draw the funds out slowly over their lifetime (subject to, you guessed it, more IRS-required distribution rules), or as quickly as they want, with no income tax.
Back-up Emergency Fund: I generally recommend at least 5% of assets be held as an “ER fund.” When emergencies arise, it is definitely better to avoid liquidating assets or borrowing quickly. Since taxes have already been paid on Roth IRA monies, these funds could be used until another solution is found.
Tax-free Lifetime Income: A Roth IRA can be used to purchase a fixed annuity. Combining the two can create a rare lifetime of tax-free income. After the death of the owner, the Roth IRA can still be rolled over to the owner’s spouse and subsequent heir(s).
Should you add a Roth IRA to your “retirement toolbox”? Consult with an adviser who is familiar with the rules and the most powerful planning techniques available.
David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show at 9AM on AM1380 Ormond Beach, AM1230 New Smyrna Beach and AM1490 Deland. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.