4 Reasons Why You Must Open a Roth IRA Before April 15
It's that time of year again. While tax season can bring a lot of stress, there are some things you can do to make it pay off for you.
One of them is to open a Roth IRA, which is a little different than a traditional IRA. The key difference is that contributions to traditional IRAs are pre-tax, while Roth IRA contributions are after tax. There are a few other differences with respect to withdrawals, but rather than focus on all of that, let's look at four reasons you should consider funding a Roth IRA this year. (See also: How to Set Up an IRA to Build Wealth)
You Can Double Your Annual Contribution
If you open up a Roth IRA by April 15, you get a great opportunity — you're still allowed to make a contribution for the previous (2013) tax year.
The most you can contribute in 2013, depending on your income and filing status, is $5,500 if you're 49 years old or younger in 2013. But if you're 50 years old or older in 2013, then you're allowed to contribute an additional $1,000, bringing your total to $6,500.
But that's just for 2013.
In 2014, you can contribute another $5,500 if you're 49 years old or younger in 2014. Similarly, if you're 50 years old or older in 2014, then you're allowed to contribute an additional $1,000 — again bringing your total to $6,500. (Check out the IRS page for more details on contribution limits.)
This means that this year, you can potentially put a total of $13,000 towards your Roth IRA to build a financially secure retirement.
Don't think that the extra $5,500 for 2013 will make a big difference?
If you put the $5,500 in an investment that grows 7% each year, then in 30 years it'll be worth over $41,800. Best of all, if you obey the rules in withdrawing the money, you get to keep all of it and won't have to pay any taxes.
What could you do with an extra $41,800?
You'll Have Better Investment Options
A lot of people have employer-sponsored retirement plans, such as a 401(k). Many, however, complain that the investment fund options available to them are poor. Specifically, these funds tend to have high expense ratios, which are the fees that go toward managing the fund. (See also: Why a Roth IRA May Be Better Than Your 401(k))
Even though all funds have these fees, they tend to be much higher in employer plans. With a Roth IRA, on the other hand, you can invest with a company that offers funds with much lower costs.
For instance, it's not uncommon that funds from employer plans cost around 0.9% each year. If you open up a Roth IRA, however, you can invest with a company that offers funds that cost about 0.2% each year.
That small amount makes a big difference over time.
Let's say you invest $5,500 each year in a fund that grows by 7% each year. If the fund costs 0.9%, in 30 years you'll have just under $439,000. That's not bad.
On the other hand, what if you invest in a lower-cost fund? If you invest $5,500 each year in a fund that grows by 7% each year, but that fund costs only 0.2%, then in 30 years you'll have over $499,000.
In other words, a difference of over $60,000. How much would it hurt you to lose $60,000?
You'll Have Tax-Free Money
With a Roth IRA, you contribute money that's already been taxed. But if you follow the withdrawal rules (the main one being to wait until you're 59 ½ years old), then you get a huge benefit. That benefit is the pleasure of spending the money — including the money earned via investments — without paying taxes. (See also: Get the Best Tax Benefit From Your Retirement Portfolio)
Let's say you invest $5,500 in a regular, taxable investment account each year, and your money grows by 7% each year. If you're in the 25% tax bracket, in 30 years you'll have just under $402,000.
But if you contribute $5,500 in a Roth IRA each year, and your money grows by 7% each year, in 30 years you'll have over $555,000. (Check out this calculator to run your own numbers.)
In other words, taxes would eat up over $154,000 of your retirement money.
You'll Have Emergency Access to Your Money
Lastly, your contributions (that is, the money that you put into your Roth) can be taken out at any time, free of taxes and penalties. This is not true, however, of earnings on your contributions, which have more complex rules. (See also: Balancing Retirement Savings, Emergency Fund, and Paying Off Debt)
Of course, since this a retirement account, you should only do this in the event of a true emergency. But it's nice to know that some of your money is available if you really need it. This is not the case for most other retirement investments you could put your money in.
Remember, tax time doesn't have to be associated only with stress. With opening a Roth IRA, there's a bright side to the season.
What other reasons for opening up a Roth IRA can you think of?