Everyone wants a big Social Security check in retirement, but it’s not easy to live on benefits alone. Most people need a nest egg to cover their expenses. There are plenty of places you can keep yours, but a Roth IRA is one of the best. Here are three reasons why you should incorporate one into your retirement plan.
1. Roth IRAs can help you grow your savings fast
Social Security was only designed to cover about 40% of the average worker’s pre-retirement income, which means you’ll likely have to cover most of your retirement expenses yourself. It’s not unreasonable to think that you might need a seven-figure nest egg, especially if you’re living a long life. Saving that much is no easy task, but a Roth IRA can speed it up.
Roth IRAs let you invest your funds so they can grow quickly. You might only earn a few dollars in interest each year with a savings account, but you could see a return of 10% or even more in a year on your investments.
Roth IRAs also give you complete control over your investments. You choose exactly what you want to invest in and change your portfolio as often as you want. You can take advantage of this flexibility to maximize your growth potential while reducing your costs.
Other retirement accounts, like 401(k)s, can also help you grow your savings, but they have more limits on investment options. This can cost you dearly in the long run.
2. Roth IRA withdrawals are tax-free
Roth IRA withdrawals are tax-free as long as you wait until you are at least 59½ years old and have owned the account for at least five years. This can save you quite a bit on your retirement taxes, and it’s great news for those worried about paying taxes on their Social Security benefits.
The federal government taxes Social Security benefits on seniors whose provisional income—their adjusted gross income, any tax-free interest, and one-half of their annual Social Security benefit—exceeds $25,000 for a single adult or $32,000 for a married couple. Some states also tax Social Security benefits.
It’s not always possible to avoid these taxes, but you may be able to do so if you stick with Roth IRA withdrawals once you approach the tax threshold for your filing status. The government won’t count these withdrawals when calculating your interim income, so you’ll get the money you need without affecting your tax bill.
3. You can make Roth IRA withdrawals at your own pace
Most retirement accounts have required minimum distributions (RMDs), which are mandatory annual withdrawals seniors must make from their retirement accounts beginning in the year they turn 72. But the Roth IRAs don’t. You already pay taxes on your contributions the year you make them, so you don’t owe the government anything more when you retire.
This means you can let your money grow in your Roth IRA for as long as you want. If you are able to cover most or all of your retirement costs with Social Security, you can leave your Roth IRA savings as a gift to your heirs.
But a Roth IRA might not be enough on its own
Although Roth IRAs have many advantages for the retirement saver, they also have one major drawback. You can only save $6,000 in a Roth IRA in 2022 if you’re under age 50. Adults 50 and over can save up to $7,000. These limits are quite low compared to other retirement accounts and may not be enough for you, especially if you started your retirement savings late or plan to retire early.
You may need to link a Roth IRA to another retirement account, such as a 401(k), so you can set aside more money for your future. Roth 401(k)s, while less common than traditional tax-deferred 401(k), are your best bet if you want tax-free retirement withdrawals. If you ever quit your job, you can transfer your Roth 401(k) funds into a Roth IRA and you won’t have to worry about RMDs anymore.
Your savings solution is as unique as your retirement, so only you can decide which accounts are right for you. But if you’ve never thought about opening a Roth IRA before, you might want to take a closer look. There is still plenty of time to make your 2022 contributions.