What do 4,758,6001 investors know about Roth individual retirement accounts (IRAs) that others don’t? Hard to say, really, but if pressed, they might offer this tip: tax-advantaged savings.

Roth IRAs are individual retirement plans that look a lot like traditional IRAs.

Instead of investing before-tax savings as you can with traditional IRAs (providing that you’re eligible), you can save after-tax money and withdraw it tax free later as long as the money meets certain requirements.

Introduced with the Tax Relief Act of 1997, Roth IRAs have grown in popularity. As of 2013, more than 23% of all IRA investors use them.1 Not bad for an investment vehicle that’s only been around for 20 years!

Here’s a look at a few of the benefits you might receive if you invest in a Roth IRA:

Tax-free compounding.

Says it all, right? When you invest in a Roth IRA, your contributions and earnings, which include dividends and capital gains, can grow tax free over time. Because you’ve already paid taxes up front, you won’t have to pay any taxes (including on those same dividends and capital gains) when you take qualified money out.2

Easier access.

Unlike other IRAs, Roth IRAs don’t penalize you when you make withdrawals from your contributions because the money has already been taxed. It’s important to note, however, that while you can withdraw any contributions you’ve made to your Roth IRA tax-free at any point, you will be taxed if you withdraw any gains the account earns if you’ve had the account for less than five years and you are less than 59½ years old. If you withdraw gains earlier than five years, you’ll be taxed on it. The five year rule for your Roth IRA earnings starts on Jan. 1 of the year you make your first contribution.

Another point to consider when it comes to Roth IRAs being easier to access is that they aren’t subject to required minimum distributions (RMDs). You can keep contributing to your account long after you reach age 70½, when other retirement accounts force investors to begin withdrawing their money.2

Fast access.

On a fixed income in retirement? Even if you’re not, it’s handy to be able to quickly get to your money. You’ll know exactly how much you can withdraw without tax worries if you get hit with unexpected expenses.

Benefits for you and your beneficiaries.

Saving money in a Roth IRA not only can cut the size of your taxable estate, it can also provide your heirs with tax-free income when you’re gone. Sure, the IRS requires minimum distributions based on life expectancy factors, but those annual distributions, which begin in the year after your death, may help to supplement your loved ones’ incomes for years to come.2

Tax-hike protection.

If you’re in the early stages of your career, chances are you’re in a relatively low tax bracket, which makes saving in a Roth IRA even more beneficial. You’ll probably earn more money as you get older, which puts you in a higher tax bracket come retirement. Being able to withdraw from your Roth IRA without worrying about a bump into an even-higher tax bracket can be helpful.3

Other investment options.

While there are tax advantages associated with investing in an IRA, be sure to consider your employer-sponsored retirement plan, such as a 401(k), as well. These plans also offer a tax-deferred investment option and may be the best investment choice for you depending on your individual circumstances.

If you’re looking at types of individual retirement plans, a Roth IRA may be right for you. Roth 401(k)s are another option that could be worth looking into as well. We’ll cover the details about those in an upcoming blog post. Before you invest, however, you may want to talk with a tax professional to understand your options and how Roth accounts can help you optimize your tax benefits.

 

1 Copeland, C. (2015, May 01). Individual Retirement Account Balances, Contributions, and Rollovers, 2013; With Longitudinal Results 2010–2013. The EBRI IRA Database. Retrieved February 22, 2017, from https://www.ebri.org/pdf/briefspdf/EBRI_IB_414.May15.IRAs.pdf
2 Frankel, M. (1970, January 01). The 4 Best Roth IRA Benefits. Fool.com. Retrieved March 21, 2017, from https://www.fool.com/retirement/iras/2015/08/04/the-5-best-roth-ira-benefits.aspx
3 Yochim, D. (2017, March 17). Roth vs. Traditional IRA: Which Is Best for You? NerdWallet.com Retrieved March 21, 2017, from https://www.nerdwallet.com/blog/investing/roth-or-traditional-ira-account/
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The information provided is general in nature, is for informational purposes only, and should not be construed as legal or tax advice. Financial Engines does not provide legal or tax advice. Financial Engines cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Financial Engines makes no warranties with regard to such information or results obtained by its use. Financial Engines disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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