Why a Roth IRA is a Must Have Plan

March 23, 2015

You are probably aware of some of the virtues of a Roth IRA. But there are at least five reasons why a Roth IRA is a must-have plan.

Tax Free Income in Retirement

This is the most obvious benefit of a Roth IRA, and it’s repeated in virtually any discussion related to the plan. Even still, this advantage is well worth reemphasizing.

Virtually every other type of retirement plan is a deferred plan. That means that the tax liability on the account – both your contributions and the investment income that the account earns – will be taxable when you start making withdrawals from the plan. At that point, the withdrawals will be added to your other retirement income, where they’ll be fully taxable at ordinary tax rates.

A Roth IRA stands alone as a retirement account from which you will be able to make withdrawals and pay no income taxes whatsoever.

Roth IRAs Are a Form of Retirement Tax Diversification

Most people probably never given this a thought, but the potential is very real that you can be in a higher tax bracket by the time you reach your sixties than you are right now. The reason will be multiple income sources. If you’re receiving income from Social Security, an employer pension, a deferred retirement plan, non-retirement investment income, or any income from continued employment, you may be earning much more money than you ever imagined.

The problem is that all of those income sources – including a percentage of your Social Security benefits – will be taxable in retirement. If you are earning $60,000 per year pre-retirement, and your income jumps to $90,000 when you retire, you may have a tax problem. You will have deferred income from a time of relatively low tax rates, only to pay higher tax rates in retirement.

This is where the tax-free nature of a Roth IRA really shines. While all of your other income sources will be creating tax liabilities, the withdrawal received from your Roth IRA will be completely tax-free. That will provide you with income tax diversification at a time when it will be badly needed. A Roth IRA is a way of making sure that at least some of your income will not create a corresponding tax liability.

Short-term Liquidity – Just In Case

Since contributions to a Roth IRA are not tax-deferred, you’ll have the ability to withdraw those contributions prior to age 59 ½ free from tax consequences. Since many people have the vast majority of their financial assets in tax-deferred accounts, this can be an important option to have.

A Roth IRA can give your portfolio some much-needed liquidity. It’s never a good idea to withdraw funds from any kind of retirement account before reaching retirement age. But it is still a good option a have. Life can be complicated, and it doesn’t always go according to our plans. A Roth IRA can give you the built-in flexibility that other retirement accounts can’t.

It Offers More Investment Choices Than an Employer Sponsored Plan

One of the frustrations that many people have with employer-sponsored plans is limited investment selection. For example, your employer-sponsored 401(k) plan may have only a half a dozen options, all of which are mutual funds. Those funds may not be anything close to the best performers in their classes. This can leave you stranded with nothing better than mediocre investment choices for the account that holds the largest amount of your money.

A Roth IRA is self-directed, just like a traditional IRA. That means that you can choose the trustee that holds the account. And in doing so, you can make sure that that trustee – typically an investment broker – provides the widest variety of investment options possible.

You can also make sure that the trustee provides the largest selection of low cost investment options. This is another limitation of most 401(k) plans. Not only do the plans themselves often have high investment expenses, but the limited investment options that you have within the plan also have investment fees that are above the norm in the market.

No Required Minimum Distributions (RMDs)

Virtually every other form of tax-sheltered retirement plan is subject to required minimum distributions, or RMDs. That means that once you reach the age of 70 ½ you are required to begin taking distributions from the plan. In fact, plan trustees are required to begin issuing RMDs when you reach 70 ½, so you won’t even have any choice.

They will take the balance of any retirement accounts that you have, and divide the balance by your life expectancy at that point in your life. You will receive distributions based on that formula, and it will apply to traditional IRAs as well as employer-sponsored plans.

There is no such requirement for RMDs for Roth IRA plans. You can literally keep your Roth IRA open and growing for the rest of your life. While other retirement plans are gradually depleting due to distributions, your Roth IRA can stay healthy and strong.

This can be an important part of an overall strategy to prevent you from out-living your money. Even as your other accounts are being drawn down by RMDs, you can allow your Roth IRA to continue growing so that you will have plenty of money in the later years of your retirement. With people now routinely living well into their eighties and even nineties, this can be an important asset preservation strategy.

If you have an opportunity to take a Roth IRA you should absolutely do so. There are just too many benefits that make it one of the most important investment plans that you’ll ever have.


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Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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3 Responses to Why a Roth IRA is a Must Have Plan

  • Big-D

    One of the biggest benefits I see is when the person who owns the Roth dies. A Roth allows 100% of the value of the account to be transferred to the beneficiaries tax free, bypassing the inheritance taxes. The only other investment vehicle that does this is insurance. My parents have moved a significant amount of money to Roths, paying the taxes, and as such when they both pass, we (the kids) get those accounts tax free.
    At that point, the kids can use it or keep it as a Roth for their own retirement. Using it is simple as you are able to pull out the principal at any time of a Roth, and a new principal was set when the transfer happened.

    • Kevin Mercadante

      That’s a good point, and it goes to show the value of the Roth as maybe the most flexible investment plan there is.


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