Roth IRAs – The Swiss Army Knife in Your Financial Belt

There are many vehicles for saving money, but few are as flexible as a Roth IRA. One can have retirement savings, emergency money, and college savings in one convenient place. Let’s explore these options in more detail.

Retirement Savings

What is a Roth IRA? In its most basic form, it is a retirement savings account where contributions are made with after-tax money and all qualified withdrawals after age 59 1/2 are tax-free. Although contributions to a Roth IRA are not tax-deductible, the IRS sets rules on who can contribute and how much. In 2021, contributions are limited to $6,000 per year ($7,000 for those age 50 and older) for individuals whose income (or income combined with their spouse’s income) falls below certain thresholds. Having Roth money available for retirement provides flexibility for those looking to manage their tax burden during their non-working years.

Emergency Money

A lesser-known fact about Roth IRAs is that you can always withdraw your contributions at any time for any reason – no questions asked and, best of all, no taxes or penalties. For example, assume over the past five years you have made contributions totaling $20,000 into a Roth IRA and the account has grown to $30,000. If your house needs some emergency repairs, you can withdraw up to $20,000 and the remaining $10,000 will continue to grow tax-free until retirement. Make sure that you are reporting and tracking your contributions each year when you file your taxes. 

Qualified Educational Expenses

Under normal circumstances, a non-qualified withdrawal of the growth portion of the Roth IRA would result in taxes and a 10% penalty. There are a few exceptions to this rule – one being the use of the money to pay for college (or other qualified education expenses). You would still owe ordinary income taxes on any earnings drawn upon, but you would avoid the penalty. Let’s go back to our example of $20,000 of contributions and $10,000 of growth. If the tuition bill is $25,000, you would be able to withdraw $20,000 tax-free and pay ordinary income tax on the remaining $5,000 withdrawn from the Roth IRA. There is also the opportunity to set up a Roth IRA in the child’s name before they reach college, but they would have to have earned income equal to or greater than the amount of contributions.

This article merely scratches the surface on this topic. There are more advanced strategies available as it relates to those who would typically not qualify due to income limits. If you are interested in exploring the possibilities, reach out to us and see how to leverage this valuable tool.

For more information, visit contwealth.com

David Rath, CFA is the Director of Portfolio Strategies at Continuum Wealth Advisors in Saratoga Springs.