One big debate in the finance world is if you should contribute to a Roth IRA before other investment vehicles. In my opinion it shouldn’t even be debated.
Contributing to a Roth IRA is absolutely a good idea.
In this article I detail why you should be contributing if you are eligible.
Note: If you do not know what a Roth IRA is, be sure to review the top nine Roth IRA questions young professionals ask that our using FitBUX’s hybrid robo-advisor.
Reason #1: Retirement Income Diversification
Retirement income diversification is a term I came up with to describe why you need to contribute to as many different types of investment vehicles as you can by the time you hit retirement.
What I mean by contributing to investment vehicles are things like a 401k, Roth IRA, real estate, etc.
The reason being that all these vehicles are taxed differently. No one can predict what future tax laws are going to be.
Therefore, if you contribute all your money into a 401k for example and tax laws change in a way that negatively affects those accounts, you are going to be in a bad situation.
Therefore, it’s a good idea to contribute $50 – $100 a month into a Roth IRA with the ultimate goal of contributing the max each year.
I believe in this so much that when I discuss financial freedom and setting up a financial plan, we always include a minimum contribution going to a Roth IRA.
Reason #2: Tax Free Gains
In short, when you retire and take the money out of a Roth IRA, the gains are tax free. Who doesn’t like making money without having to pay taxes?
Reason #3: Roth IRA as an Emergency Fund
Most people think you can not take money out of a Roth IRA without being taxed. That is only partially true.
That law only applies to gains. Therefore, the money you contribute into the Roth IRA you can withdraw anytime without penalty.
For example, if you contributed $6,000 a year to a Roth IRA for 5 years and lets say the account is now worth $40,000.
This means you have contributed $30,000 and have gains of $10,000. Therefore, you can withdraw $30,000 penalty free anytime you want to.
The number one reason why people say they don’t contribute to a Roth IRA is because they might need the money before they retire.
However, that is a bad reason. You could simply contribute the money into the Roth IRA and invest it in cash so it doesn’t lose value. Therefore, using a Roth IRA as an emergency fund.
You would want to do this because you can’t make up contributions for years you miss. This means you can’t go to the Federal government and say “I didn’t put money into my Roth IRA in 2020 so I want to do an extra $6k this year.”
You can only contribute to your Roth IRA in the given year.
In short, using a Roth IRA as an emergency fund makes contributing to one a good idea.
One note, if you can’t afford to lose the money, make sure when you contribute to your Roth IRA it is invested in cash, not the stock market!
Reason #4: Roth IRA as a Down Payment For A House
Just like above, you can take your contributions out of your Roth IRA.
However, you can also withdraw additional money if its for a down payment on a house.
You can withdraw $10,000 of gains tax free and penalty free as long as it qualifies as first-time home purchase and the Roth IRA has been established for at least 5 years.
Maybe Another Reason Or Way To Use A Roth
A lot of people love the above features so much that they want to rollover their 401(k)s to a Roth IRA. However, there could be major tax consequences before doing this. Therefore, if you are contemplating this, be sure to ask your tax accountant first.
In short, yes you should contribute to a Roth IRA because it gives you an investment with tax-free gains and retirement income diversification.
It also gives you flexibility to withdraw money in case you need it unlike other retirement vehicles.
If you need help opening a Roth IRA, be sure to become a member of FitBUX and we can help you open it using our hybrid robo-advisor. If you want to speak with someone before deciding if you should open one, be sure to schedule a free call with one of our FitBUX Coaches.