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Most people consider the Roth IRA to be oneretirement account, which makes sense considering that's what it was originally designed for.
But the Roth IRA has some unique features that make it much more flexible than other retirement accounts. Really, a Roth IRA is resourceful enough to be used effectively for almost any financial goal, from the short term onwardsemergency savingsPlease planpension savings.
With that in mind, this post will explain exactly why Roth IRAs are the ultimate savings account, including five specific financial goals they are especially good for.
Quick note:If you do thatToo manyIf you want to contribute directly to a Roth IRA, you may still be able to contribute through eitherBackdoor Roth IRAof die eneMega backdoor Roth IRA.
The Unique Flexibility of Roth IRAs
There is one key feature of the Roth IRA that makes it much more flexible than other retirement accounts.
Most people know the basics of how a Roth IRA works:
- Contributions are after-tax (they are not tax deductible)
- Your money grows in the account tax-free
- You can withdraw your money tax-free when you retire
A lot of peopledoesn'tknow is that you can withdraw the amount you contributed to your Roth IRA at any time, for any reason, without taxes or penalties.
Let's say you've contributed $20,000 to your Roth IRA over the years, and your investment returns have grown that balance to $25,000. You may withdraw up to $20,000 from your Roth IRA at any time, regardless of how old you are and what you use the money for, without incurring taxes or penalties. You can use that money however you want.
The remaining $5,000 will be taken into accountincome, and in most cases, you'll face both taxes and a 10% penalty if you withdraw before age 59.5. Although we'll talk about some exceptions later.
But it's the ability to access your contributions, along with a few other special features, that allows you to use your Roth IRA for a variety of financial goals that other retirement accounts can't.
Now let's talk about all the different ways you can use your Roth IRA.
Quick note:Direct contributions to a Roth IRA are immediately available for any reason, but funds converted into a Roth IRA are subject to aWaiting period of 5 yearsbefore you can withdraw it without tax or penalty.
1. Retirement savings
The obvious and primary use of a Roth IRA is to...pension savings. The fact that your money grows tax-free and can be withdrawn tax-free is pretty powerful.
The truth is that the benefit of tax-free withdrawal is often overestimated, and in many cases it isa traditional IRA is actually a better bet.
Still, a Roth IRA is a great way to save for retirement and can also provide some tax diversity if you're already contributing a significant amount to your retirement.a 401(k) or other tax-deferred investment account.
2. Tuition fees
Most people think twice529 planerwhen they're thinking about college savings, and it's generally the best option if you're 100% sure you want to spend the money on higher education.
But Roth IRAs have three special features that make theman excellent college savings account:
- You can withdraw your contributions at any time for any reason, including educational expenses.
- Any income you take out of your Roth IRA that is used for higher education expenses isexempt from the normal 10% early withdrawal penalty(assuming your Roth IRA has been openminimum 5 years). This income is taxed, but avoiding the 10% penalty is a major cost savings.
- If you don't end up needing the money for college, you can simply keep it in the Roth IRA and use it for retirement.
If you aren't alreadywell on the way to retirement, or if you simply want to maintain some flexibility while saving for college in a tax-efficient manner, a Roth IRA is a good choice.
3. Acute fund
Yes, a Roth IRA may be a reasonable place to put ityour emergency savings.
First, because you can access your contributions at any time, money in a Roth IRA keeps them available in case of an emergency.
Second, you can keep all or part of your Roth IRA in a money market fund, which is basically the same as a savings account. That way you know the money will be there when you need it, which is the key to emergency savings.
Third, by putting it in your Roth IRA, you can take advantage of that valuable tax-deferred space before it's gone.
Ideally, you would be able to keep your emergency fundin a regular savings accountand use your Roth IRA for long-term investments. But if the alternative is not to contribute to an IRA at all, making a contribution is probably a smart move.
If an emergency arises and you need the money, it will be there. If not, your money can grow tax-free for decades.
And finally, once you've built up your traditional savings, you can put that Roth IRA money into itlong-term investmentsso it can grow even faster.
4. Buy a house
If you are buying a home for the first time, which one?The tax authorities define asif you haven't owned a home in the past two years, you can withdraw up to $10,000 from your Roth IRAincome, both tax-free AND penalty-free, against a home.
This is in addition to the ability to withdraw the amount you contributed, meaning a potentially significant amount of your Roth IRA money can be used to purchase a home without incurring taxes or penalties.
Now there are a few pitfalls to be aware of:
- The $10,000 exception is a cumulative lifetime limit.
- You can only qualify for the exception if you have had your Roth IRA open for at least 5 years.
- If you're depending on your Roth IRA money for retirement, taking it out to buy a house may not be the best idea.
This is a strategy that should be used with caution, but it is yet another way your Roth IRA is available to you.
5. Save for your child
If your child has thatincome from labor, you should consider opening a Roth IRA for him or her.
It would have to be a custodial account, meaning you could control the account, but the money would actually belong to your child. However, most major investment firms offer these, so it shouldn't be difficult to do (I personally use Vanguard).
And this has some big advantages:
- You can explore the concepts of saving and investing together and help your child build these skills early.
- Starting early can give your child a huge head startfinancial independence.
- And again, because Roth IRAs are so flexible, this is money your child can use for a number of purposes as he or she grows older.
You can read more about whether your child is eligible and how to open an account here:Why and How to Open a Roth IRA for Your Child.
Roth IRA: The Ultimate Savings Account
Given how accessible the money in a Roth IRA is, it's hard to think of a reason not to contribute.
The worst-case scenario is that you contribute today, have a large unexpected expense tomorrow, and run out of money in your checking and savings accounts to pay for it. In that case, you can simply withdraw your Roth IRA contributions to make up the difference.
And the best-case scenario is that your money grows tax-free for years, after which you can withdraw it tax-free for retirement or withdraw it at minimal cost for bigger goals like college or a house.
So if you haven't yet maximized your IRA contributions for the year, now is a good time to consider contributing money to a Roth IRA before the tax benefit is gone for good.
