What exactly is a Roth IRA — and why should you have one?

FINANCIAL ADVISORS


When investors are deciding where to stash their cash for retirement, there are several options.

Americans rely more and more on saving in their employer-sponsored 401(k) plans — which are heavily funded by tax-deferred salary deferrals from the employee and tax-deferred employer matching contributions.

Once employment ends, these 401(k) plan accounts are often rolled over into an individual retirement account for purposes of managing the portfolio and continuing the tax advantages previously enjoyed in the 401(k).

However, a big opportunity often missed in this area is Roth savings. The current landscape and rules around retirement savings provide a number of strong incentives for you to consider setting up a Roth IRA this year.

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With Roth tax treatment of your savings, money goes in after tax. But the investment gains are tax-deferred, and if you meet certain requirements, you can withdraw all of the investment gains tax-free. In order to receive the investment gains tax-free from a Roth IRA, the account will need to have been open for five years and you must qualify for a trigger event, such as the following:

  • When distributions are made on or after the IRA owner reaches age 59½.
  • After the death of the IRA owner.
  • After a disability in which the IRA owner can’t do any substantial work.
  • If a withdrawal, of up to $10,000, is being used for first-time home-buying expenses.

The five-year rule makes it wise to set up a Roth IRA as soon as possible. As soon as money goes into any Roth IRA, the five-year period begins. The rule allows for aggregation back to the first Roth IRA contributed to in order to satisfy the five-year rule. This means you need one Roth IRA to satisfy the five-year rule for any other Roth IRAs opened in the future.

The rule also looks at tax years. In 2019 you can still contribute to a Roth IRA for 2018 until April 15. This would technically start the five-year clock as of 2018. It’s also important to note that if you are saving in your Roth 401(k) account and roll it over to a Roth IRA, the years it was open in the 401(k) don’t carry over to the Roth IRA. If you have a Roth 401(k), consider opening a Roth IRA and contribute to start the five-year clock, as you will likely do a rollover to a Roth IRA at some point.



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