More than 40 percent of people in the US won’t have enough money to be financially secure in retirement. If you’re one of them, it may be time to review the options available for your retirement savings.
1. Tax-Free Growth Potential
When you contribute to a Roth IRA, you’re using after-tax dollars. You don’t receive a deduction on your income taxes, but any investment income or gains inside the plan are tax-free. It’s a great financial planning tool for the future.
If you begin making contributions when you’re young, you have time on your side. The contributions in a Roth IRA will grow tax-free for longer. It’s a great way to build wealth that you can withdraw in the future.
If you believe that tax rates will go up in the future, a Roth IRA will protect you from paying a high tax rate on the earnings in your plan. You save tax today with a 401k plan, but you’ll pay tax at a higher rate on your contributions and investment earnings when you withdraw them.
2. Withdrawals Are Tax-Free
You can withdraw contributions and earnings from a Roth IRA free from federal income taxes when you meet certain conditions. The withdrawals may be free from state and local taxes as well.
With a Roth IRA, you pay tax on your income today instead of paying tax on your withdrawals in the future. When you contribute to a 401k, you receive a tax break today, but you will pay taxes when you withdraw the money in the future. If you inherit a Roth IRA, distributions are tax-free in most cases.
3. Access Your Money Anytime
When you have a Roth IRA, you can take out your money when you need it, even if you haven’t reached the early withdrawal age of 59 1/2 years. The earnings in your account might be taxable if the account is less than five years old.
You can avoid penalties in specific circumstances. Here are some of the situations where this would apply:
- qualified education expenses
- a limited amount for a first time home purchase
- qualified birth or adoption costs
- certain medical or health insurance payments if you’re unemployed
After age 59 1/2, if you’ve held your Roth IRA for more than five years, all of your withdrawals are tax and penalty-free. You also have the option of leaving your money in the Roth IRA, allowing it to grow tax-free until you need it.
Early withdrawals from a 401k can attract fines and a tax penalty of 10 percent. This is on top of the federal and state income tax owing on the amount you take out.
These amounts add up, so it’s better to leave your money in a 401k plan until you reach the age of 59 1/2. Then you can take out your money without penalty, but you will pay tax.
These complex rules depend on quite a few factors. If you’re planning to withdraw your money early from either plan, consult a financial professional for advice.
4. Minimum Distributions Aren’t Required
Traditional IRA and 401k plans require that you take out specific withdrawals once you reach the age of 72. These are called required minimum distributions or RMDs. You must calculate the RMD amount each year and withdraw it as taxable income.
These required withdrawals can be a problem for future tax planning. A Roth IRA has no requirement to take out minimum amounts, making it a more flexible tax planning product. Inherited Roth IRAs do require minimum distributions.
5. You Control Your Retirement Savings
An IRA is a retirement account that an individual can open independently. Your employer opens a 401k on your behalf. Roth IRAs are a flexible option for employees with 401k plans as you can contribute savings to both plans at once. An IRA has lower contribution limits than a 401k.
A Roth IRA gives you the ability to change jobs without losing your savings. You don’t have to roll over savings plans to a new employer’s account or keep track of old 401k accounts. A Roth IRA lets you make contributions as long as you work, no matter who you work for.
6. Gain Flexibility When You Retire
You can decide when to take out the money when it’s in a Roth IRA, and it’s tax-free as long as you follow the rules. You can take a combination approach and manage your income tax bracket in retirement.
You could take money out of a 401k up to a tax bracket, paying a lower tax rate. Then you could top up your income by taking the rest from your Roth IRA.
7. Flexible Estate Planning
The rules for an inherited Roth IRA are different than a 401k. The advantages and disadvantages of using a Roth IRA vs. a 401k are complex. They can be an essential part of your estate’s financial plan.
It’s important to contact an expert if you will use a Roth IRA as part of your estate planning. With a Roth IRA, distributions are still tax-free to your heirs, but they must take out minimum distributions.
8. You Can Convert Your Savings
If you have savings in a traditional IRA or 401k, you have the option to convert some of that money over to a Roth IRA. You’ll have to pay tax on the money when you move it over. Any investment income earned in the future would be tax-free in the Roth IRA.
Conversions may affect your Medicare or Social Security benefits, so it’s good to understand the rules before deciding. Consult with a professional to find out the best option for you.
Benefits of Roth IRA Over 401k
Most people don’t think about their retirement needs until they are ready to create a plan. That’s an excellent time to meet with our professional team. We are your trusted retirement planning services partner, and we will design the retirement plan that is right for you.
Contact Bogart Wealth today to discuss the benefits of Roth IRA over 401k plans. We are happy to provide wealth management services in McClean, VA, and Greater Houston, TX.