I often refer to the Roth IRA as one of the most versatile investment tools for retirement because it has so many unique features and different ways to support a retirement plan.
On the surface, it can look like any other investment tool, but once you look behind some of the more common benefits and see how they can actually be used, you might just feel like MacGyver once you add one to your plans.
To start, it fills the age-old rule of not putting all your eggs in one basket. Since the money that goes into a Roth is already taxed, it comes out tax free in retirement. That’s a very different approach than the more traditional IRA, 401(k), and 403(b).
This is one of the more commonly known aspects, so let me give you some practical uses for it as well as some of the other benefits including the ability to withdraw principal at any time, the fact that there are no required minimum distributions at age 701 ½, and the added perk that it can be passed on to heirs tax free as well.
Combined, the Roth IRA can become the ideal piggy bank for a number of retirement plan situations.
1) Life Happens
Even the best laid plans can go awry before retirement. As a result of an emergency or once in a lifetime opportunity, investors may need access to funds but face taxes and penalties with more traditional retirement savings tools. The Roth IRA, however, allows investors to withdraw contributions tax-and penalty free, and serve as a last resort, rainy day fund.
2) Health Care Costs Before Reaching Medicare eligibility
One of the biggest expenses facing retirees under the age of 65 is health care costs. Funding a Roth to support your plan or a spouses desire to retire at age 62 for example, can be accomplished with just three short years of maximum contributions (assuming average monthly health care costs are $500 per month and the ability to use catch-up provisions).
Earmarking the Roth for this specific purpose takes some of the pressure off figuring out your retirement budget and jumping into a higher tax bracket due to withdrawing too much from other pre-tax retirement savings vehicles.
3) Long-Term Care Costs
One of the biggest threats to retirees and their families is the future costs of long-term care. The numbers can be downright staggering with some reports pegging current costs at $2,000-$3,000 per month for private care.
Funding a Roth for this purpose provides investors with a balanced approach to long-term care. First, depending on their age and the time horizon for its use, investors can generally opt to be more aggressive with their allocation in this account since they may not need this type of care until they are in their late 70’s or early 80’s. Second, if they never use it for care, they can spend it during retirement or pass it onto heirs. With a longer time horizon it’s easier to turn that $5,000 year contribution limit ($6,500 if your over 50) into a sizeable sum to help offset some long-term care costs.
4) Longevity Insurance
Investors today know that it’s very possible for them to live 20, 30, or even 40 years into retirement. That’s a long-time to stretch out traditional IRA, 401(k), or 403(b) monies. By establishing a Roth to help fund the later years of retirement, retirees can take a two-tier approach to managing risks in the stock market. For example, by being conservative with their 401(k) and other IRA savings that can avoid some of the worry and concern of major market fluctuations. Then with their Roth, take a more aggressive approach which may produce more ups and downs but overtime, may also provide higher, long-term returns.
Additionally, if they never have to use the assets for this purpose, they should be well positioned to be the favorite grandma or grandpa who passes funds onto the grand kids for their first car, college, or other major life events.
Overall, The Roth IRA can be considered the Swiss Army Knife of retirement because of its versatility and ability to turn everyday investors into MacGyver type problem solvers when it comes to certain aspects of their retirement plan. However, there are some caveats that can blow up if they aren’t careful.
First, investors must have earned income to qualify; second there are income limits which dictate how much you can contribute, and finally, investing these funds aggressively may not be an appropriate strategy for everyone. You can learn more about the Roth IRA at the IRS website, talk to a financial professional about your risk tolerance, and for those interested in learning more about using a Roth 401(k) you can click here.
