There are myriad different types of traditional and Roth IRAs available to retirement savers. For many people, Roth IRAs make sense because they can help you build retirement nest eggs while providing tax benefits and flexibility. Choose the right Roth IRA for you by following these questions and tips.
Learn How to Choose a Good Roth IRA. After all It’s About More Than Tax Savings.
Roth IRAs, named for the income tax paid on contributions up to the amount of a traditional IRA contribution, offer a powerful way to get tax-free retirement growth.
However, their existence makes taking cash out of a Roth IRA without paying taxes more tricky. No such problem, however, with the two key types of Roth IRAs, they’re described in Chapter 9.
Traditional, Roth IRAs
Let’s get these basics out of the way:
A traditional IRA or 401(k) is a tax-deferred retirement account that allows you to take your retirement savings out tax-free when you retire. Because the money in a traditional IRA is taxed when it comes in, a traditional IRA is designed to be a more conservative retirement savings vehicle than a Roth IRA.
A Roth IRA is tax-free, but withdrawals before retirement age count as taxable income for years. If you take cash out of a Roth IRA without paying taxes, you’ll also owe a 10% early withdrawal penalty on the amount you withdraw. This option is only available to younger people.
What if you want to withdraw cash and aren’t retired?
In fact, you can withdraw from your Roth IRA without paying tax or penalties. All you have to do is put the money you withdraw in a Roth-based retirement account, such as a SEP IRA or solo 401(k). An individual age 59½ can withdraw any amount from a Roth IRA if it’s being used to pay qualified higher education expenses. However, if you withdraw the cash from a Roth IRA early, you’ll owe a 20% tax penalty and a 10% tax on the amount of your distribution — both the income tax you owe and the 10% early withdrawal penalty.
An IRA rollover
An IRA rollover is an easy way to withdraw cash from a retirement account and have the money count as taxable income in a different tax year.
You can roll over funds from your traditional IRA, from a 401(k) or from a pension plan, either into another IRA, or into your new employer’s plan, such as a 401(k). In this case, you don’t pay taxes or a penalty on the money, either. However, the first-year contributions you make to the new IRA will be subject to tax.
Deposits from an inherited Roth IRA
An inherited Roth IRA is a retirement account that is typically inherited from a spouse.
Because the inherited Roth IRA becomes taxable once you have access to it, it’s important to plan ahead before you need to take money out of the account. Remember that you can either start a new account or move money out of the existing Roth IRA and into another IRA, either a Roth IRA or a traditional IRA.
Many experts recommend retiring with a Roth IRA, which means any money taken out before retirement age will be considered taxable.
While you can use the former approach to roll over your inherited Roth IRA, the advantages of the latter aren’t lost. But make sure to take the right amount of time to recoup your original investments: A $100,000 initial investment might take five to eight years to grow to $100,000. Once you have access to a Roth IRA, paying taxes on that amount isn’t a big deal if the value has increased significantly.