The Major Pros and Cons of Roth IRAs
Investing in a Roth IRA is touted as the best retirement savings plan by most financial experts. The promise of a friendly taxation regime is undoubtedly appealing to investors. However, there are some major pros and cons of Roth IRAs. The lucrative promises that accompany an investment in Roth IRAs are accompanied by limitations that apply to investors depending on their unique situation.
The pros and cons of investing in Roth IRAs can be summarized as follows:
The major advantage of Roth IRAs is the flexibility that it affords investors. The flexibility can be broken down into different components that form the major selling point of Roth IRAs. The first one being the flexibility regarding the age of contributors. In theory, Roth IRAs are open to any person below 59½ years of age, provided their income is within a specified limit, and they make contributions after tax deductions. The accruing advantage of this is that any amount considered to be a small contribution, such as $50 or $100, can be invested under this plan.
The flexibility of Roth IRAs is also witnessed in the ability to make withdrawals on the principle investment without attracting a tax penalty. The flexibility to withdraw the principle contribution provides a double benefit for investors because the retirement savings plan can also serve as an emergency fund when push comes to shove. The earnings can also be withdrawn tax-free and without penalty once the investor qualifies for distribution at age 59½.
The distributions are also flexible based on one’s needs and capabilities. For example, once a contributing member reaches age 59½, they qualify for distributions, and they can retain their money in the plan without facing withdrawal conditions such as minimum periodic distributions.
First, Roth IRAs are restrictive to personal growth. Regulators have placed annual contribution limits, and investment participation is prorated based on specified income levels (varies annually). An investor who contributes more than their prescribed limit risks attracting a 6 percent tax penalty on the excess contributions if they aren’t withdrawn and filed as taxable income.
Secondly, all contributions to Roth IRAs are taxable. The contributions do not offer any tax breaks to the investors. The classification of the contributions to Roth IRAs as part of the gross taxable income makes the plan highly inconvenient for young investors or investors seeking short-term tax incentives.
The third disadvantage of Roth IRAs is the highly punitive tax slapped on the investor if any withdrawals are made from their earnings before the qualification period. Withdrawal of earnings before maturity attract a 10% fine on the total earnings withdrawn, and a subsequent standard tax rate is applied to the same amount.
Another disadvantage of Roth IRAs, as a retirement savings plan, is the possibility of a tax bracket change later. Changing tax brackets can be disruptive to a retiree’s plans because a change in the tax code means that the amount of distributions will change drastically. However, this occurs only to those who continue receiving taxable income after the maturity of their Roth IRA fund. The fact that most people are putting their money in alternative investments makes it probable that withdrawals from the Roth IRA will be subjected to a higher tax code because of other taxable incomes that the pensioner might be receiving.
To learn and understand more about the pros and cons of Roth IRAs, register for a free tax planning event near you.