Understanding the Pros and Cons of a Roth IRA
Taxes First Rather Than Later
Contributions to a Roth IRA occur after the IRS taxes your income. This differs from a traditional IRA. That means, when you retire, you do not have to worry about paying taxes on the contributions you made to a Roth IRA. You do, however, pay taxes on the interest income for money that accrued in the account beyond your contributions. If you plan on being in a lower tax bracket later in life, the tax savings could be huge versus a traditional IRA.
You may withdraw any contributions made to the account without penalty at any time. That means a Roth IRA can double as an emergency fund. For example, if you contribute $1,000 in the first two years of the fund, you can withdraw any amount up to and including $1,000. Any interest, or the amount more than $1,000, gets taxed with a penalty.
Low Starting Amounts
Many companies in the market compete for your business. As such, the starting amounts for Roth IRAs may come in relatively low compared to similar accounts. Start with your bank to see if it has a Roth IRA option for you, but several nationwide firms such as Charles Schwab, Fidelity, Vanguard and T. Rowe Price offer Roth IRAs.
One key disadvantage is that a Roth IRA benefits people who start retirement savings early. The reason stems from the rule that interest earned in the account must remain for a minimum of five years or you pay a penalty. Interest income, plus a 10 percent penalty for an early withdrawal, means you give up more money in taxes. However, you do not have to take required mandatory distributions starting at age 70 as with a traditional IRA.
The IRS limits the amount you can contribute to a Roth IRA at $5,500, or $6,500 if you are over age 50. Plus, your income must be under a certain level or you cannot contribute to a Roth IRA at all. If you cannot contribute to an IRA, you must find other ways to invest in the future such as mutual funds, stocks or similar instruments.
A Roth IRA has advantages and disadvantages as you choose financial instruments to help you retire with the right amount of money saved up for your nest egg. When you get ready to talk to your bank about opening a Roth IRA, keep in mind several key points that may factor into your decision. Learn the pros and cons of a Roth IRA with the following information.