Retirement Savings

Should I Have a Roth IRA?

February 16, 2017
Given its potential for tax-free growth, a Roth IRA may be a smart savings tool for many investors.

Key Points

  • Qualified withdrawals from Roth IRAs are tax-free.
  • Roth IRAs are not subject to required minimum distributions.
  • Roth IRAs offer financial flexibility since you can make withdrawals for large expenses, if qualified, without generating taxable income.
  • Even in their 50s and 60s, most investors can benefit from Roth IRAs.

Much like a Traditional individual retirement account (IRA), a Roth IRA allows an investor to grow any potential earnings in a tax-advantageous way. The Roth IRA’s big benefit, however, occurs once an investor is ready to start withdrawing money. Your contributions to a Roth IRA—along with any earnings—if qualified, can be withdrawn tax-free. By comparison, any growth in a Traditional IRA is only tax-deferred, and—generally—withdrawals from a Traditional IRA are taxed as ordinary income.

INCOME FLEXIBILITY IN RETIREMENT

While contributions to a Traditional IRA may be tax-deductible when made, contributions to a Roth IRA don’t qualify for a tax deduction. However, for most investors, contributing to a Roth IRA can help maximize spendable income in retirement. Withdrawals from a Roth IRA are tax-free if you are age 59½ or older and have held the account for at least five years at the time of withdrawal. That means you can count on withdrawing all funds without having to set aside a portion for taxes. In addition, you only need to take distributions from a Roth IRA if you need them. With a Traditional IRA, you must take required minimum distributions (RMDs) from your account each year, beginning with the year you reach age 70½. RMDs may be part of your adjusted gross income, which means they can affect your tax situation.

WHEN A ROTH IRA IS APPROPRIATE

Two factors will help you decide whether a Roth IRA is appropriate for you: your expected tax rate in retirement and the amount of time before you’ll withdraw from the account. If you think you’ll be paying a higher tax rate in the future, consider a Roth IRA. Withdrawals from a Traditional IRA may be taxed at that potentially higher future rate, while any Roth IRA withdrawals could be tax-free.

Even if you expect your tax rate to stay the same, a Roth IRA could still make more sense. The longer you have until retirement, the more advantageous a Roth IRA’s tax-deferred growth potential can be. Eligibility to contribute fully to a Roth IRA depends on income, however. There are limits: Single filers with a 2017 modified adjusted gross income of $133,000 or more are unable to contribute ($196,000 or more for married couples filing jointly).

A MORE DIVERSIFIED TAX SITUATION

Roth IRAs also allow you to diversify your retirement income from a tax perspective. For example, say you’re planning for a large, one-time expense in retirement. If you increase your withdrawals from a Traditional IRA to cover the cost, the added income could push you into a higher tax bracket. A Roth IRA, on the other hand, may allow you to withdraw the extra funds tax-free—providing both flexibility and more spendable income in retirement. All investments involve risk, including possible loss of principal.