Individual retirement accounts offer an easy way to maximize your retirement savings. A Roth IRA can be particularly attractive given that withdrawals are tax-free in retirement, provided certain conditions are met. As a result, this portion of your retirement income stream won’t be diminished by income taxes.
That’s a distinct contrast to traditional IRAs. Contributions to traditional IRAs may be fully or partially tax deductible, but the money is taxed when it’s withdrawn in retirement. While you can’t deduct your contributions to a Roth IRA, the assets in a Roth account have tax-free growth potential for the life of the account.
“A lot of people save in a traditional IRA because they like getting a lower tax liability today,” says Mitchell Franklin, an assistant professor of accounting practice at Syracuse University. “But it actually makes sense to pay a little tax today with a Roth IRA and save more in taxes over the course of your life.”
In 2013, you can contribute a maximum of $5,500 ($6,500 for those age 50 or older) to a Roth IRA, as long as your adjusted gross income is under $112,000 for singles or $178,000 for married couples filing jointly.
Here are three key reasons to consider a Roth IRA:
Tax-free growth. Money in a Roth IRA can grow tax-free. Young investors may find this particularly helpful, since they can benefit from a long period of tax-free growth potential. “The younger you are when you start putting money away, the faster your growth can compound,” says Franklin. “With a Roth, it can compound tax-free.”
Potential tax savings. If you think you’ll be taxed at a higher rate in retirement than you are now, a Roth IRA may be especially useful. You’ll pay taxes on that income now, when rates are presumably lower, and withdraw the funds tax-free later—meaning you’ll save on taxes over the long term. “People used to assume that you’d be in a lower tax bracket when you retire, since your income generally goes down,” says Franklin. “But if you look at the current deficit, the reality is we’re probably going to have to raise taxes.”
No minimum distribution requirements. Traditional IRAs require you to start taking minimum distributions once you turn 70-and-a-half years old, whether you need the money or not. Roth IRAs, on the other hand, have no minimum distribution requirements, so your money can continue to grow tax-free until you need it.
Keep in mind that the cost of long-term care is rising—the 2013 median annual rate for a private nursing room is $83,950, much of which is not covered by Medicare.1 As a result, access to a pool of tax-free money in a Roth IRA may be a valuable part of your financial safety net in retirement.