Whenever it’s tax season, we hear a lot about IRAs and how they can help us. Here are five of the major tax benefits that a Roth IRA can provide.
Disclaimer: This information is updated for the 2015 tax year. For complete and up-to-date rules of a Roth IRA, please visit IRS.gov or speak with a licensed financial advisor.
1. Tax-Free Growth
After you contribute money to a Roth IRA, it can be invested into many different investments, and your investments grow without you being charged income taxes. This means that buying, selling, dividends, interest, coupons, and other transactions inside of the Roth IRA are excluded from income taxes. But remember, if you take money out of the account, you need to be careful of the rules.
2. Tax-Free Retirement
One of the most popular reasons to start a Roth IRA is to take withdrawals from your account tax free during retirement. As long as your account is at least 5 years old and you are at least 59 ½ years old, you can take money out of a Roth IRA tax free. As much as you want…whenever you want.
3. Other Tax-Free Money
The money that is used to contribute to a Roth IRA is after-tax money. In other words, you’ve already paid your income taxes on this money. This means that you can take money back out of the Roth IRA up to the limit of what you have already contributed.
Example: You contribute $5000, and after a while it grows to $6000. You can take out $5000, tax-free, whenever you would like, but that extra $1000 of growth could be taxed or penalized (depending on your specific situation).
4. Special Situations for Tax-Free Money
The IRS has rules that allow you to take out tax-free money from your Roth IRA in special situations. Some of those are:
- Buy, Build, or Rebuild a First Home
- Back taxes
- Health Insurance During Unemployment
The above situations are just a couple. To see the full list, visit IRS.gov
5. Tax-Free Income for Your Family
If you have money in a Roth IRA, and you pass away, there are really only two ways it can go. If you name your spouse as a beneficiary, he or she can roll that money into their own Roth IRA and treat it just like it was their own money. However, if your beneficiary is anyone besides your spouse, their options are limited. Essentially, they can start receiving tax-free income (RMDs based on their age) or take out all the money and pay any income taxes due.
6. No Income Tax Deductions
Ok, I know this isn’t a tax benefit, but I wanted to make sure you realize that if you contribute to a Roth IRA, you DO NOT get to take any deductions on your income taxes. If you want tax deductions, you might want to consider a Traditional IRA. However, the rules are different and a little more complicated than a Roth IRA, so please speak with your accountant or financial advisor for more strategies, ideas, and advice.