Tax season doesn’t have to be all about dread, as it is a time when you can reap some financial benefits. One of the most important moves to consider is opening a Roth IRA before April 15. The Roth IRA has a few key distinctions from traditional IRAs – primarily that your contributions are made post-tax and there are certain rules about withdrawals, but we’ll dive into that later.
Here are four reasons you should consider funding a Roth IRA this year:
Double Your Annual Contribution
If you open a Roth IRA by April 15, you’re given the unique opportunity to contribute funds for both the current tax year and the previous one (if applicable). In 2013, the most you could put in was $5,500 if you were 49 years old or younger. However, those who are 50 years or older were allowed an additional contribution of $1,000 – bringing their total to a respectable $6,500.
But that’s not all! In 2014, the annual contribution limit remained the same for individuals younger than 50 ($5,500) and increased by another $1,000 for those 50 and over ($6,500). This means you can potentially invest up to a total of $13,000 in your Roth IRA in two consecutive years.
Better Investment Options
Another significant advantage is that with a Roth IRA, you have more control over the expense ratios (fees that go towards fund management) for your investments. In employer-sponsored retirement plans like 401(k)s, these fees are often higher – it’s not uncommon to find them as high as 0.9% per year.
However, if you open a Roth IRA, you can select funds with much lower expenses. For instance, there are plenty of options available that only charge an annual fee of about 0.2%. While this may seem like a small difference, it’ll make a big impact over time.
Let’s use the example of investing $5,500 each year in a fund that grows at 7% annually with either a 0.9% or 0.2% fee. In 30 years:
- If the fee is 0.9%, you’ll have about $439,000 (not bad).
- If the fee is only 0.2%, your investment will grow to over $499,000 – that’s an additional $60,000!
- Tax-Free Money
In a Roth IRA, you can also benefit from tax-free withdrawals of your earnings. If you invest money in a traditional, taxable account and grow it by 7% annually for 30 years while being in the 25% tax bracket, you’d have just under $402,000. But with a Roth IRA, that same sum could balloon to over $555,000.
It’s important to note that this is not true for most other retirement investments; they do not offer such tax-free growth opportunities.
Emergency Access to Your Money (To an Extent)
While your Roth IRA is a long-term savings account, it does provide some flexibility in times of emergency. You’re allowed to withdraw your contributions (i.e., the money you put into the account) at any time without penalties or taxes – as long as it’s a true emergency and not simply a cash crunch.
Just remember that the earnings on your contributions have more complex rules surrounding their withdrawal, so it’s crucial to consult an expert before doing so.
Tax season doesn’t necessarily have to be stressful; with some strategic planning, like opening a Roth IRA, you can use this time to your advantage and reap substantial financial benefits down the line. Don’t miss out on these opportunities!
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