Roth IRA Pros and Cons
A Roth IRA is an individual retirement account. It earns tax-free interest, and you can withdraw contributions without being taxed. Roth IRAs are funded with both Pretax and after-tax dollars, meaning that you could have more money available in retirement even though you have already paid taxes on the money.
You might wish to include a Roth IRA as part of your portfolio. While traditional IRAs are the most prevalent IRA choice, Roth IRAs have their own set of Roth IRA Pros and Cons, such as tax-free withdrawals and taxed contributions.
What is Roth IRA?
Roth IRA is an acronym for "Individual Retirement Account." The Roth IRA was introduced by the Taxpayer Relief Act of 1997. It is used as a retirement tool, allowing people to put money into it tax-free during their working life and take it out without being taxed in retirement. Thus, one can withdraw contributed funds anytime without any penalty or tax obligation. Until 2010, the maximum contribution has been $5,000 with an annual income up to $95,000. However, the IRS ended inflation adjustment on Roth IRA limits starting 2011.
Roth IRA is an individual retirement account (IRA) managed by the Internal Revenue Service (IRS). To distinguish between it and other types of IRAs, people often call Roth IRAs "after-tax" accounts. This distinguishes them from the traditional IRA, where contributions are tax-deductible, and earnings grow tax-deferred.
What are Roth IRA Pros?
Roth IRA's offer some unique advantages to investors. One of the pros is that investors can withdraw their contributions at any time without incurring a 10% penalty. This is different from a traditional IRA, which requires you to wait until you are 59 1/2 years old to make withdrawals. Roth IRA’s also offer a higher maximum contribution than a traditional IRA.
1. Tax-free withdrawals
One of the most attractive Roth IRA benefits is distributions on contributions. Since these amounts have already been taxed, they can be taken out at any time without penalty or additional taxation.
2. No required minimum distributions
Roth IRA assets are not subject to required minimum distribution (RMD) rules during your lifetime. This means that you can pass this account onto your heirs without incurring hefty estate penalties.
3. Even lower income earners are eligible for a Roth IRA
Anyone with earned income can contribute to a Roth IRA as long as their annual income falls below certain limits; in 2017, this limit is $196,000 for individuals and $133,000 for married couples filing jointly. Although these limits increase slightly every year, they remain at fixed, low levels compared to traditional IRA contributions.
4. One of the major Roth IRA Pros is that anyone can open it
Unlike 401ks and other employer-sponsored retirement accounts, there is no requirement that you work for the bank or brokerage that offers your Roth IRA account. You are free to choose whatever institution you wish to provide these services. Don't be discouraged if your current bank doesn't offer a Roth IRA option; open an account with another one instead.
5. Tax diversification
Roth IRAs allow tax diversification. This means that some of your assets will always be sheltered from taxation since all of your contributions were made on after-tax dollars. In addition to these Roth IRA Pros, any losses incurred in the Roth IRA market will shield your other investments from taxation.
What are Roth IRA Cons?
Roth IRA cons include the contributions to be taxed immediately. Contributions can also be withdrawn from the account without incurring any tax consequences. The investments in a Roth IRA are considered a type of retirement account, and thus, there is no maximum age limit on who can contribute to the account.
1. Taxable contributions
One of the cons of Roth IRA is that you have to pay income taxes on the money you contribute since it has already been taxed. In effect, this means that you lose some of your contributions each year to taxes, creating an even larger taxable base for future years' contributions. The only way around this problem is to claim the standard deduction instead of itemizing deductions—but if you do not use the standard deduction, then a portion of each contribution will be lost every year.
2. Contributions are capped
Roth IRA maximum limits dictate how much can be contributed per year. These limits vary age and change every few years, but no matter how old you are or your income, there is a maximum amount that can be contributed to a Roth IRA in any given year. So if you've already hit the current cap for your age group, you'll have to wait until next tax season to make another contribution.
3. The RMD rules don't apply
Roth IRAs do not require required minimum distributions (RMDs). This means that while traditional IRAs allow funds to be depleted by an increasing percentage every year, Roth IRA withdrawals must continue at the same rate indefinitely.
Therefore, if you fail to take out this minimal amount each year, this failure will result in additional taxation when you eventually begin taking out money from the account.
4. Converting traditional IRA funds to a Roth IRA can be costly
If you have a traditional IRA, then converting it over to a Roth IRA will cost you. While the initial contribution is not taxed, any money taxed before being deposited into your original IRAs must be counted as part of the conversion. If you have already paid taxes on this amount, you will lose it during the conversion process. And this is one of the major Roth IRA cons for many.
5. Disqualifying factors are rare Roth IRA Cons
In addition to income limitations, there are situations in which individuals are disqualified from contributing directly to their Roth IRAs. For example, suppose an individual has access to a retirement plan at work (this includes 401ks as well as other plans).
In that case, they cannot contribute more than the maximum for their respective filing status or face additional taxation. This money may still be placed into a Roth IRA, but it must go through a special process called a "backdoor" contribution.
Conclusion on Roth IRA Pros and Cons
The Roth IRA is a valuable tool that can help someone save for retirement. However, there are many disadvantages to consider when deciding whether or not this account option will work for you. Some insight into the pros and cons of a Roth IRA can help you make an informed decision about your financial future.