Roth IRA and why you probably need one – Updated for 2022

Roth IRA is a tax-exempt investment account that allows you to make after-tax contributions to save for retirement. The Roth IRA has a tax-free status. It is a great way to save for retirement and meet your financial goals without paying a dime for taxes on your investments. It offers you a lot of flexibility with very few constraints.

Roth IRA is an excellent starting point for young professionals. It can help you reach your financial goals faster. So open your account now to maximize its full potential. Investing early in your career will lay out the path to your financial independence.

1. Plan for your future

Opening a Roth IRA account is a great way to plan for retirement and build financial independence. This tax-free account is an excellent saving opportunity for many young professionals and anyone with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

If you are single and earn $129,000 or less in 2022, you can contribute up to $6,000 per year to your Roth IRA. Individuals 50 years old and above can add a catch-up contribution of $1,000. If you are married and filing jointly, you can contribute the full amount if your MAGI is under $204,000.

There is a phaseout amount between $129,000 and $144,000 for single filers and $204,000 and $214,000 for married filing jointly.

2. No age limit

There is no age limit for your contributions. You can contribute to your Roth IRA at any age as long as you earn income.

Minors who earn income can also invest in Roth IRA. While youngsters have fewer opportunities to make money, many sources of income will count – babysitting, garden cleaning, child acting, modeling, selling lemonade, distributing papers, etc.

3. No investment restrictions

Unlike most 401k plans, Roth IRAs do not have any restrictions on the type of investments in the account. You can invest in any asset class that suits your risk tolerance and financial goals.

4. No taxes

There are no taxes on the distributions from this account once you reach the age of 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either. Roth IRA is a great saving tool for investors at all income levels and tax brackets.

With an average historical growth rate of 7%, your investment of $6,000 today could bring you $45,674 in 30 years, completely tax-free. The cumulative effect of your return and the account’s tax status will help your investments grow faster.

If you are a California resident, your maximum tax rate on ordinary income can be over 52.5% – 37%  for Federal taxes, 13.3% for State Taxes, and 2.35% for Medicare. This figure excludes Social security and self-employment tax.

The maximum long-term capital gain tax in the US is 23.68%. California residents could pay up to 13,3% on their capital gains as California doesn’t differentiate between long-term and short-term gains.

5. No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contribution (but not the return) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

6. Diversify your future tax exposure

Most of your retirement savings will likely be in a 401k plan or an investment account. 401k plans are tax-deferred, and you will owe taxes on any distributions. Investment accounts are taxable, and you pay taxes on capital gains and dividends. In reality, nobody can predict your tax rate by the time you need to take out money from your retirement and investment accounts. Roth IRA adds this highly flexible tax-advantaged component to your investments.

7. No minimum distributions

Unlike 401k plans, Roth IRA doesn’t have any minimum distributions requirements. Investors can withdraw their savings at their wish or keep them intact indefinitely.

8. Do a backdoor Roth conversion

Due to recent legal changes, investors who do not satisfy the requirements for direct Roth IRA contributions can still make investments in it. The process starts with a taxable contribution, up to the annual limit, into a Traditional IRA. Eventually, the contributions are rolled from the Traditional IRA to the Roth IRA.

9. Roth conversion from Traditional IRA and 401k plans

Under certain circumstances, converting your Traditional IRA and an old 401k plan to Roth IRA could make sense. If you expect to earn less income or pay lower taxes in a particular year, it could be beneficial to consider this Roth conversion. Your rollover amount will be taxable at your current ordinary income tax level. An alternative strategy is to consider annual rollovers in amounts that will keep you within your tax bracket.

10. Estate planning

Roth IRA is an excellent estate planning tool. Due to its age flexibility and no minimum required distributions, it is a good option for generation transfer and leaving a legacy to your beloved ones.

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