Why A Roth IRA Makes Sense For Millennials (and Everyone Else) - Good Money Sense (2024)

It has been said that there are two things certain in life: death and taxes. The first thing I can’t help you with. But for the second, I can with a type of retirement account called a Roth IRA. With this particular type of account, your account’s balance that you see is what you get. Uncle Sam doesn’t get a cent of it.

For young professionals – aka Millennials in their 20s and 30s, the Roth IRA is one of the best ways to save for your retirement. Retirement may be decades away, but the sooner you start, the bigger your nest egg.

If you are older, the Roth IRA still makes sense. The government even encourages you to contribute by increasing the yearly contribution limit by $1,000 when you hit 50 or older.

Here are seven reasons why you should have a Roth IRA.

Tax Advantages Of A Roth IRA

With other retirement accounts such as a traditional IRA and 401k, you get a tax deduction for the money you put into the account. Your money will then grow tax-free, but you will pay taxes in the future when you take the money out in retirement. The bigger your account, the more taxes you will pay.

Roth accounts are the opposite. The funds you put in are already taxed. Your money will then grow tax-free and when you take money out of the account in retirement, all of your earnings are completely free from taxes too.

The Roth IRA is best if you think you’ll be in the same or higher tax bracket in retirement. This is something most people don’t think about since for many their primary source of taxable income comes from their job. For those who are savers and planners, taxable sources of retirement income could include withdrawals from tax-deferred retirement plans, pensions, investment income, passive income from real estate, annuities, and maybe even your social security.

Roth Accounts Do Not Have Required Minimum Distributions

Roth IRAs do not have required minimum distributions (RMDs) that tax-deferred accounts like traditional IRAs, 401k’s, 403b’s, SEP-IRAs, and SIMPLE IRAs require by law. For those accounts, once you turn 70½ years old the government wants their tax money even if you don’t need to take a distribution to pay for your everyday living expenses.

For accounts that require a RMD, you will have to calculate the amount each year and pay your taxes owed. An account owner must calculate the RMD for each IRA or 401k account they own, which can be a lot of administrative work if someone had a 401k at each job they held throughout their life and neglected to roll it over into a IRA.

Failure to withdraw a RMD, failure to withdraw the full amount, or failure to withdraw it by the required deadline will result in a stiff penalty of 50% tax on the amount not withdrawn.

This is not the case with a Roth. You never need to take the funds out if you have enough money for your daily living expenses. This brings us to the next benefit of a Roth IRA.

Leave Money To Your Heirs Tax-Free

Unlike other retirement accounts which may require you to start taking RMDs after you turn 70½, you can continue to make contributions into your Roth IRA as long as you have earned income. This allows you to use your Roth as an estate planning tool.

Your heirs will inherit your Roth IRA when you pass away. They will have the option to rollover the inherited Roth into their own Roth IRA or take tax-free distributions from the Roth. According to IRS Publication 590, Roth IRAs that are not rolled-over must be distributed within five years of the date of death or taken as an annuity over the beneficiary’s life.

Access Your Roth IRA Money Before Retirement

Unlike other retirement accounts, a Roth IRA allows you to withdraw your contributions any time without paying taxes or penalties. This is a big difference from tax-deferred accounts like a 401k or traditional IRA. For those accounts, withdrawing your money before 59½ years of age will result in a 10% early withdrawal tax penalty plus paying the income tax on the amount.

For any earnings over your contributions such as interest, capital gains, and dividends in your Roth IRA, the following rules apply if you are under 59½ years old and want to withdraw your earnings:

For Roth IRA accounts opened more than five years

Your earnings will not be subject to taxes or penalties if you meet the following conditions:

• Withdrawals up to $10,000 to pay for a first-time home purchase
• You are the beneficiary of a deceased Roth IRA account owner
• You become permanently disabled

For Roth IRA accounts opened less than five years

You can avoid a penalty but have to pay taxes on the earnings for the following situations:

• Withdrawals up to $10,000 to pay for a first-time home purchase
• Withdrawals to pay for qualified education expenses
• Withdrawals to pay for unreimbursed medical expenses more than 10% (7.5% for 2018) of your AGI
• Withdrawals to pay for health insurance premiums if you are unemployed
• The distributions is due to an IRS levy of the qualified plan
• The distribution is a qualified reservist distribution
• The distributions are part of a series of equal periodic payments
• You are the beneficiary of a deceased Roth IRA account owner
• You become permanently disabled

All other reasons for withdrawing your earnings early will result in a10% early withdrawal penalty. By earnings, I’m talking about the amounts over your original contributions you’ve put in.

The IRS has the following rules on which order your distributions are taken out:

1. Regular contributions
2. Conversion and rollover contributions, on a first-in, first-out (FIFO) basis
3. Earnings from contributions

Use A Roth For Your Mortgage Down Payment

As seen above, if you need money for a down payment on your first home, you can pay for it with earnings from your Roth IRA account if it has appreciated due to the recent bull market without any taxes or penalties.

Ideally, you wouldn’t touch the money until retirement, but the option is there. This $10,000 lifetime limit is per person, so a couple can take out $20,000 if they each have a Roth.

Use A Roth IRA To Pay For College

Perhaps you want to go back to college to get a graduate degree like a MBA to earn a higher salary. You can tap your Roth to pay for qualified education expenses, which includes tuition, textbooks, and room and board.

Your Roth IRA contribution withdrawals are naturally tax and penalty free. Since college tuition has been skyrocketing to the moon, you can also use the earnings for educational expenses without penalties, but they will be taxable if you are under 59½ of age.

For parents and grandparents, Roth IRA funds can be used to pay for their children’s or grandchildren’s college education. The Roth IRA offers an additional flexibility over the 529 plans which are usually used for saving for education. Money saved in a 529 plan that is not used for educational expenses will become taxable as ordinary income and also be subject to a 10% penalty. The Roth IRA however, lets you keep the unused funds for retirement income. This could be helpful if your child decides college is simply not for them.

Another benefit of using a Roth for college savings is IRAs are not considered in financial aid need analysis, which could affect the amount of your child’s financial aid awards.

Avoid Future Tax Hikes

It is impossible to know what will happen in the future. The national debt is currently sitting at over $21.6 trillion. The government may increase taxes in the future to pay for it’s spending. They may even try to pass laws to try to tax your Roth IRA. There is no way to predict how things will change but we do know with the current regulations, traditional IRA and 401k accounts are taxed at whatever tax rates are at the time of your distribution at retirement.

Closing $ense

When you are younger and just starting out in your career, you usually tend to make less money. Yes, this means you might have less money available to save for retirement. But it also means you are in a lower tax bracket.If you think you will be paying higher taxes in the future from job promotions and salary increases, it would make sense to contribute to a Roth IRA now to hedge against higher taxes later.

When you are in a higher tax bracket, the tax deduction from contributing to a traditional IRA and 401k would come in handy since it reduces your taxable income. No one wants to pay more taxes than they have to!

Those with occupations such as doctors, who start out getting paid less during training might even want to look into contributing to a Roth 401k if available to take advantage of being in a lower tax bracket during their lower earning years.

My preferred order of saving for retirement with limited funds is to contribute at least enough into a 401k or 403b to get the match from your employer since that is free money. Then contribute to a HSA if you qualify. Then the Roth IRA. Finally, go back and put much as you can into your 401k until you max out your yearly limit.

Do you have a Roth IRA? What is your preferred way to save up for the future and retirement?