Parents often lecture children about the importance of saving a few pennies here and there whenever they get a little money. Those pennies can add up, children are told.
A Roth IRA allows you to practice such saving on a much larger scale. A Roth IRA is a retirement account funded by after-tax contributions. Qualified distributions of contributions and earnings are not taxed. Experts say taking full advantage of a Roth IRA or a Roth 401(k) is among the best ways of mitigating some of the tax burdens in retirement.
“A Roth IRA can be set up by any financial institution and can hold a multitude of investment options,” said Nick J.D. Olesen, a private wealth manager with the Philadelphia Group in King of Prussia, Pennsylvania. “I do not recommend investors open up any account through a bank or credit union, as those institutions mainly recommend CDs for the investments and do not have access to other investments.”
Roth accounts allow retirees to withdraw income completely free of taxes after the later of attaining the age of 59 ½, or a five-year holding period for the first contribution.
“This obviously can help one plan for being within a certain tax bracket in retirement if they are able to access income from their investments that doesn’t get eaten up by Uncle Sam,” said Kasey Gahler, a certified financial planner.
Gahler, of Austin, Texas-based Gahler Financial, adds that most tax-advantaged accounts, such as IRAs, do not allow investors to access funds prior to the age of 59 1/2 without a 10 percent penalty.
He explained, however, that there are several ways around that stipulation including the Substantially Equal Periodic Payments (SEPP) calculation. It allows the account holder to withdraw funds before the stipulated age, granted the same amount is taken annually until the later of five years or attaining the age of 59 1/2.
The Internal Revenue Service has outlined three ways to calculate the SEPP amount, Olesen said. Each is based on the investor’s age and either the interest rates or Required Minimum Distribution tables.
Other ways which allow investors to access funds from tax-advantaged accounts, such as IRAs, prior to the age of 59 1/2 without a 10 percent penalty include:
- Distributions to the extent the individual’s unreimbursed medical expenses exceed 7 ½% of his adjusted gross income
- Qualified higher education expenses of the taxpayer, spouse, child or grandchild
- First-time home purchases (no home ownership in prior two years) limited to $10,000
- Disability or death
In addition, a one-time tax and penalty-free transfer can be made from an IRA to a Health Savings Account (limited in 2014 to $3,300 for self-only coverage and $6,550 for family coverage, plus A $1,000 catch-up contribution if you're 55 or over).