Roth IRA Benefits
Traditional IRA or Roth IRA? That is the question many investors face when planning for retirement. The issue is deeper than just whether you want tax-deferred or tax-free growth. You need to consider your immediate tax issues and anticipated future income scenarios to understand the potential benefits of Roth IRAs.
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Tax-Free Distributions
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Growing assets tax-free is the obvious benefit of a Roth IRA, but one that is not fully understood. The Roth IRA must be owned for at least five years and the owner must be at least age 59 1/2 to receive tax-free distributions. There is no income deduction when Roth contributions are made, as there is with the tax-deferred traditional IRA. Regardless of the investments you choose and how much growth there is, there are no tax consequence as long as money remains in the account. The Roth is suitable for an investor who doesn't benefit from taking the annual deduction and wants to reduce taxable income in retirement.
Early Distribution Access
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The Roth IRA allows you to take distributions prior to the normal distribution terms, provided certain regulations are followed. Early distributions from Roth IRAs have earnings added to income, and those earnings also are assessed a 10 percent penalty. The IRS does allow access without penalty for a first-time home purchase. No more than $10,000 can be used for a first home for you, your child or grandchild. You may also use Roth funds to pay for college expenses for yourself, spouse, child or grandchild. The 10 percent penalty also is waived for distributions to owners who are permanently disabled. Though the penalty is waived, the earnings are still added to income.
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Capital Access
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One benefit of early Roth IRA distributions is how the IRS does its accounting of distributions. The IRS considers contributions as the first money to come out of the IRA. This means that regardless of your age, you can access your principal money without paying taxes or penalties. Only the earnings are taxed and penalized. So if you have $30,000 in a converted Roth IRA that grows to $45,000, you can withdraw $30,000 without tax consequence.
Inheriting Benefits
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An IRA avoids probate, which gives beneficiaries quick access to money upon your death. The Roth IRA also passes to beneficiaries without having to pay income taxes. All IRA assets are included in the taxable estate, which may require a payment of up to 35 percent in federal transfer taxes if the estate is over $5 million. A Roth IRA beneficiary also may rollover the inherited IRA into a beneficiary Roth IRA, taking only annual required minimum distributions (RMDs) and allowing the rest of the money to grow tax-free based on investment choices.
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