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  • Writer's pictureAntonise De Wet

Roth IRA: What is it and how does it benefit me?

An individual retirement account (IRA) is a type of retirement savings account. A Roth IRA is a form of tax-advantaged individual retirement account into which you can make after-tax contributions. The fundamental advantage of a Roth IRA is that your contributions and earnings can grow tax-free and be withdrawn tax-free beyond the age of 5912, if the account has been open for at least five years. In other words, you pay taxes on funds deposited into a Roth IRA, but all future withdrawals are tax-free. Roth IRAs are very similar to standard IRAs, with the only difference being how the two are taxed. Roth IRAs are established with after-tax resources, which means that contributions are not tax deductible, but funds are tax-free once withdrawn.



Why should you consider a Roth IRA?

A Roth IRA can be an excellent savings vehicle for those who anticipate being in a higher tax rate in the future, making tax-free withdrawals even more appealing. However, there are income limits for starting a Roth IRA, so this sort of retirement account is not available to everyone.


Creating a Roth IRA

A Roth IRA must be formed with an institution that has been approved by the IRS to offer IRAs. Banks, brokerage firms, federally insured credit unions, and savings and loan associations are examples. Individuals typically open IRAs through brokers. A Roth IRA can be opened at any time. Contributions for a tax year, however, must be made by the IRA owner's tax-filing date. Normally, this occurs on April 15 of the following year. The deadline for the 2021 tax year, however, is April 18, 2022. When an IRA is founded, the IRA owner must get two essential documents:

  • The IRA disclosure form

  • The adoption agreement and plan paperwork for an IRA

These explain the laws and restrictions that must be followed by the Roth IRA, and they constitute an agreement between the IRA owner and the IRA custodian/trustee. Not all financial institutions are the same. Some IRA providers offer a diverse range of investing alternatives, while others are more limited. For your Roth IRA, almost every institution has a different fee structure, which can have a major impact on your investment returns. Choosing a Roth IRA provider will be influenced by your risk tolerance and investing preferences. If you intend to be an active investor who makes a lot of trades, you should look for a provider with cheaper trading expenses. If you neglect your investments for an extended period of time, some providers may even charge you an account inactivity fee. Depending on the type of investments you choose in your account, some providers provide a wider variety of stocks or ETFs than others.


Likewise, pay attention to the particular account criteria. Different providers have different minimum account balance requirements. If you intend to continue banking with the same organization, check to see if your Roth IRA account offers any additional banking services. Look into any IRA fee discounts offered to current clients if you're considering starting a Roth IRA at a bank or brokerage where you already have an account.


What advantages does a Roth IRA offer?

The potential tax savings is what draws investors to a Roth IRA. A Roth IRA can be preferable to a standard IRA if you anticipate being in a higher tax band in retirement than you are now. Your higher tax rate won't result in a big tax payment when it's time to enjoy your hard-earned money because you've already paid taxes on your contributions.


Rising inflation is another factor making the Roth IRA appealing. Over time, inflation reduces the value of money. You won't have to pay taxes in retirement, when they might be higher, if you pay them now. Additional advantages of a Roth IRA include:


  • No required minimum distributions: Roth IRA account holders are not subject to the required minimum distributions required from a traditional IRA or 401(k) beginning at the age of 72. This implies that, unlike typical IRAs and 401(k)s, account holders are not required to withdraw dividends at any time while they are alive. It's worth mentioning, though, that inherited Roth IRAs are subject to RMDs unless you inherit them from a spouse. In some cases, there are particular rules.

  • No income tax on inherited Roth IRAs: If you leave a Roth IRA to an heir, they can withdraw tax-free as long as the account has been kept for at least five years at the time of the account holder's death.

  • Withdrawals are simple: You can withdraw your contributions at any moment, without incurring any taxes or penalties. (Withdrawing investment earnings may result in taxation or penalties.

  • You can contribute to a Roth IRA in addition to an employer retirement plan, such as a 401(k).

  • You can contribute to a Roth IRA whenever and whatever much you want. For example, you may contribute the maximum amount on the first day of the year, or you could spread your contributions out over the year.

  • Extra time to contribute: You have until the previous calendar year's tax deadline to make contributions for the previous calendar year — for example, if you want to make Roth IRA contributions for 2022, you can do so until April 2023.

  • Tax-free withdrawals: Once you reach 5912, and have kept the account for at least five years, you can take distributions from a Roth IRA, including earnings, without incurring federal taxes.

  • There is no upper age limit for opening: A Roth IRA can be opened at any age as long as you have earned income (you cannot contribute more than your earned income).

Take Away

A Roth IRA is an individual retirement account (IRA) that lets you to withdraw money tax-free after reaching the age of 59, and after holding the account for the five-year holding period. You can also withdraw without penalty if you use your Roth money to buy a home, pay for college, or for the birth or adoption of a child. Roth IRAs are funded with after-tax money, so while you don't enjoy the upfront tax break of a regular IRA, you can withdraw your contributions after completing the withdrawal criteria without paying federal or state income tax on the amount.


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