4 Ways a Roth IRA Is Icing on the Retirement Cake

If you’re already saving to a 401(k), the Roth IRA may seem like an unnecessary addition to your retirement plan — something like eating a brownie for dessert after you already had the cake. But in reality, the Roth IRA complements your 401(k), like icing for a cake you’ve already put in the oven. Read on to learn about four Roth IRA features that’ll improve your financial flexibility and sweeten your retirement.

1. Access your contributions in a pinch

A lesser-known fact about Roth IRAs is that you can withdraw your contributions at any time without taxes or penalties. This is because Roth contributions aren’t tax-deductible, so the IRS doesn’t impose restrictions on them. You can still get hit with an early withdrawal penalty on a Roth, but only if you pull out the earnings.

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The ability to access your contributions adds some flexibility to your retirement planning. That can be very useful when you consider all the things in your financial life that could change between now and retirement. Maybe you want to retire early, or you are unsuccessful at paying off your credit card debt, or you have an unexpected expense that your emergency fund won’t cover.

Reaching into your Roth early is never ideal, but it may be the solution that keeps the rest of your retirement plan intact and moving forward.

2. Take tax-free withdrawals

Qualified retirement withdrawals from your Roth IRA are tax-free. On paper, that’s an advantage when you expect your tax rate in retirement to be higher than it is today. In practice, having a source of tax-free retirement income also has emotional benefits. You’ll be less affected by tax changes, budgeting for living expenses will be easier, and you’ll have some power to manage your tax bill by pulling more or less from your taxable accounts in a given year.

Normally, you can start taking tax-free withdrawals of contributions and earnings from your Roth after the age of 59 and a half. There is an additional requirement that at least five years must have passed since your first Roth contribution.

3. No effect on taxability of your Social Security

The IRS taxes between 0% and 85% of your Social Security benefit. Where you fall in that range depends on your “combined income” for the year. Combined income is half of your Social Security benefit plus other income, including taxable retirement distributions, wages, interests, dividends, and capital gains.

If your combined income is less than $25,000 as a single filer or $32,000 for married filers, the IRS doesn’t tax your Social Security benefit at all. You’ll pay taxes on 50% of your benefits if your combined income is between $25,000 and $34,000 as a single filer or between $32,000 and $44,000 as a married filer. If you exceed the upper end of those ranges, then you’ll pay tax on 85% of your Social Security benefit.

Here’s the kicker. Roth distributions aren’t considered in the combined income formula, because they’re not taxable. Save enough to a Roth and you could use that tax-free income to keep a greater share of your Social Security benefit.

4. No RMDs for you

RMDs, or required minimum distributions, are taxable withdrawals you must take from certain retirement accounts starting in your 70s. They’re designed to be payments that slowly reduce your account balance over your expected lifespan.

401(k)s and traditional IRAs are both subject to RMDs, but Roth IRAs are not. That gives you the option to leave the money in your Roth IRA to build your inheritance on a tax-deferred basis. Once you’ve passed, beneficiaries other than your spouse will probably have to withdraw the funds within 10 years, but those withdrawals should be tax-free.

A Roth IRA gives you options

One thing that makes retirement readiness so difficult is the amount of time it takes to implement the plan. You can estimate your retirement living expenses, plus your expected Social Security income and the savings balance you think you’ll need. But over the decades that follow, your life can unfold very differently from what you’d planned.

The Roth IRA is a nice resource when planning for an uncertain future, because it’s flexible enough to address different situations. Retire early, use the funds to manage your tax liability, or leave the money invested for your heirs. With the Roth IRA, you have options. And when it comes to your finances, there’s nothing sweeter than that.

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