Tax Time: A Season of Opportunity series
If saving for retirement has lagged behind saving for higher education, new home purchases or other competing needs – a Roth IRA may provide a solution.
The Roth IRA is a powerful tax-advantaged account that allows you to put your retirement first, while maintaining flexibility for other financial priorities.
Roth IRA for Retirement
Saving for retirement may seem daunting for many Americans, but the Roth IRA is a tax-advantaged account intended to help you achieve your retirement goals. The IRS generally levies a 10-percent penalty on distributions before age 59½ this is to encourage investors to leave money in their retirement accounts until it’s needed for retirement.
Withdrawing funds from an IRA prior to retirement can negatively impact the long-term potential of the account by incurring penalties by the IRS.
The IRS specifies circumstances of where the Roth IRA could potentially be used for more than just retirement, including emergencies, qualified higher education expenses, even your first home purchase. However, the purpose of the account is saving for retirement.
As Tony Madsen, CFP and president of NewLeaf Financial Guidance, says in a recent article
“I would rather my clients have cash sitting in a Roth IRA earmarked for an emergency than having them forgo Roth IRA contributions and leave cash sitting in a savings account unused.” However, due to the more involved process of withdrawing funds from a Roth IRA, he adds, “I wouldn’t do this with funds we may need in the next six months.”
Roth IRA for Higher Education
One of the largest expenses many people encounter is the cost of higher education. With more than $1.3 trillion in debt
, student loans are now the second-highest consumer debt category – behind only mortgage debt and higher than both credit cards and auto loans.
Thus, it’s no surprise that many younger investors choose to save for college before they save for retirement. Parents are falling behind on their retirement savings focusing instead on saving for their child’s education.
With a Roth IRA it might be possible to do both – save for retirement and use the funds for qualified education expenses if needed.
According to IRS Publication 590-B
, funds used for qualified higher education expenses can generally be distributed early from an IRA (before age 59½) without facing the usual 10-percent penalty. These expenses may include tuition, room & board (if at least a part-time student), fees, books, supplies and equipment and can be used for you, your spouse, or your children and grandchildren.
Roth IRA for First Home Purchase or Build
Another early distribution exception covered in IRS Publication 590-B
is the ability to avoid the 10-percent penalty on up to $10,000 withdrawn to buy, build, or re-build your first home. If both you and your spouse are first-time homebuyers, each of you can potentially receive distributions up to $10,000 for a first home without having to pay the 10-percent penalty.
Early IRA distributions may also be made without the 10-percent penalty for the following exceptions, according to IRS Publication 590-B
Roth IRA for Emergency and Unexpected Expenses
You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1952) of your adjusted gross income.
You are totally and permanently disabled
The distributions are not more than the cost of your medical insurance due to a period of unemployment.
It’s widely referenced that we should all have between three and nine months’ worth of income saved in an “emergency fund.”
Although slightly less liquid and accessible, a Roth IRA has the potential to serve as a retirement account that can be used for emergencies.
In addition to early distribution exceptions, there’s another way to use a Roth IRA for other expenses that might arise. It’s possible to withdraw contributions (not earnings) from a Roth IRA before age 59½ without additional penalties. The only requirement is the account must be established for at least five years. This means you could withdraw funds you’ve contributed to a Roth IRA in the event you need them and don’t have other options.
As always, it’s important to consult with your financial advisor or tax professional to discuss your financial goals and unique circumstances before making any financial decisions. Please review the early distribution exceptions and requirements in IRS Publication 590-B
for more information on the topics discussed in this post.
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if you’d like to learn more about the versatility and tax- advantages of Roth retirement accounts. If you’re interested in opening a Roth IRA or other account at Equity Trust, please call 855-673-4721 to speak with a Senior Account Executive.