It is never too early to plan for retirement, regardless of how old you are. Seemingly insignificant choices made now can have a profound impact on your future. While you may already be contributing to an employer-sponsored retirement plan, an Individual Retirement Account (IRA) enables you to make additional retirement contributions while offering the possibility of tax benefits. There are various IRA varieties, each with advantages and conditions. Traditional, Rollover, and Roth IRAs are the three most common options.
An IRA that accepts after-tax contributions is known as a Roth IRA. Roth IRAs are funded with after-tax money. The main advantage is that if the account is open for 5+ years, your contributions and the returns on those contributions can grow tax-free. They can also be withdrawn tax-free after the holder reaches 59.5 years of age. Since taxes are deducted from the money at the moment of deposit, all withdrawals after that are tax-free.
Other advantages of Roth IRAs include no age limitations for contributions. You may contribute at any age if you have an eligible earned income. This makes it ideal for retirement planning. Gains from investments and contributions accrue tax-free. Your heirs’ withdrawals from your Roth IRA will not be taxed. In addition, unlike a Traditional IRA, there is no requirement to make minimum distributions.
Your Modified Adjusted Gross Income (MAGI) will decide whether you are eligible to start a Roth IRA and how much you can contribute. Numerous Roth vs. Traditional IRA calculators help determine which IRAs you qualify for.
Another option is a Roth IRA Conversion. In this scenario, income taxes must be paid on converted funds in the conversion year, but there are still benefits to converting to a Roth IRA. One reason is that your retirement tax bracket will be higher than during your employment years. In this case, paying taxes now is preferable to paying them at a higher rate once you’ve quit working. Although it may seem unlikely, paying more taxes in retirement is possible, mainly if you are still in your prime earning years or have a sizable nest egg in your retirement funds. It can make sense to convert at least part of a Traditional IRA now rather than later.
If you don’t need to access your IRA funds during your lifetime, converting to a Roth IRA permits your investments to grow without being reduced by RMDs. This decision will leave more money for your heirs, who can withdraw the cash tax-free as long as they adhere to IRS distribution guidelines.