Reasons to use
a Roth IRA
for early retirement
Roth accounts offer advantages
to early retirees
Early retirement is an achievable aim, but it requires some smart thinking when it comes to taxes. Incorporating Roth strategies into the mix can help shape a tax-free retirement approach. A Roth 401(k) is one option, though it may not be available to every employee. A Roth individual retirement account, on the other hand, could be a more accessible way to plan for an early exit from the workforce.
"By saving in a Roth IRA now, your money is growing tax-free and will be taken out tax-free, meaning you will only have to withdraw what you need to fund your retirement."
— Tony Drake
"By saving in a Roth IRA now, your money is growing tax-free and will be taken out tax-free, meaning you will only have to withdraw what you need to fund your retirement," says Tony Drake, founder and CEO of Drake & Associates in Waukesha, Wisconsin.
Here are seven benefits of using a Roth IRA for early retirement planning.
Contributions can
be withdrawn
at any time
Traditional IRAs impose a 10% penalty for withdrawals of contributions and earnings made before age 59½. Roth accounts are, by nature, better suited to early retirement withdrawal strategies. "A Roth IRA is the only tax-favored retirement vehicle in which a saver can access some of the funds without an IRS penalty prior to age 59½," says Marc Labadie, partner at The R.O.W. Group in Nashville, Tennessee.
Original contributions can be withdrawn without triggering the early withdrawal penalty. That makes a Roth IRA more attractive for someone who may be planning to retire in their 40s or 50s and needs to have assets that are readily available to draw on as an income stream.
Growth accumulates
tax-free
One of the best features of a Roth IRA account for retirement is the ability to enjoy tax-free distributions starting at age 59½. This can help with planning a withdrawal strategy when there are other retirement accounts in the mix.
"The best strategy to make the most of a Roth IRA is to build it up while working, then actually leave it alone for the early retirement phase of life," says Ben Barzideh, a wealth advisor at Piershale Financial Group in Barrington, Illinois. "During the early retirement phase, you want to live off of money in
qualified retirement accounts, as you'll be in a lower tax bracket usually than preretirement
and you want to
create taxable
income in that
phase of life."
Greater tax
predictability makes
planning retirement
budgets easier
Retiring early poses some unique challenges to investors, because the money in a portfolio may need to last three or four decades. A Roth IRA can be better equipped than a traditional 401(k) or IRA to meet that challenge because tax uncertainty is eliminated.
"All the contributions have already been taxed and you get to keep 100% of the growth," says
Matthew DeFelice,
a partner at U.S. Financial Services. "Unless you can accurately predict what tax rates will be in the future when you take money out of your 401(k) or IRA, it's difficult to know how much money you'll actually have to spend after taxes are paid."
A Roth IRA makes it easier to gauge when to tap those assets in early retirement and how to space out withdrawals to stretch those dollars further.
Roth IRA conversions
open the door for
high-income earners
The IRS excludes higher earners from making Roth IRA contributions directly but there is a work-around. "
A strategy that can be employed if your income is too high to make an outright Roth contribution is the backdoor Roth, where you make a nondeductible traditional IRA contribution and immediately convert it to a Roth IRA," says Delvin Joyce, a financial planner at Prudential in Charlotte.
The trade-off is that the amount converted is taxable. Investors can spread the tax burden out by constructing a Roth conversion ladder, in which amounts are converted each year before retiring early. The key is to start a Roth IRA ladder conversion at least five years before the money is needed, experts say.
Roth assets
offer spending
flexibility
Covering basic living expenses may be priority No. 1 when planning for early retirement, but there are other ways a Roth IRA can prove useful. "Roth IRAs can also be used for your children's college savings goals," Joyce says. "Since your after-tax contributions can be withdrawn at any time without penalty or taxes, you could pull money out to pay for college expenses."
This assumes, of course, that a Roth IRA is just one part of a well-rounded retirement plan that includes other assets such as a traditional
401(k), taxable investments,
cash savings or tax-advantaged
funds held in a health
savings account.
Stock market
volatility may be
more easily managed
Stock market movements are unpredictable to say the least, and for the early retiree, there may be less room for error when attempting to ride out waves of volatility. Roth accounts, when used in conjunction with other investment vehicles, can help offer some insulation against up and down movements.
"The strategy of contributing to a Roth IRA invested in a fixed index annuity, in the conservative to moderate part of a portfolio, will help avoid future market losses and continue to accent the gains," says Jim Merklinghaus, founder of JM Wealth Management in Vero Beach, Florida. "When the stock market is up, you use your gains to live on and when it's down, you move over to your Roth IRA."
Fill the gap before
Social Security
kicks in
Social Security represents one part of the three-legged retirement stool but it can end up being a phantom leg for early retirees. "The earliest you can claim Social Security is age 62, so until then you'll need to have other sources of income," DeFelice says. Additionally, the cost of taking Social Security early must be considered.
Social Security represents one part of the three- legged retirement stool but it can end up being a phantom leg for early retirees. "The earliest you can claim Social Security is age 62, so until then you'll need to have other sources of income," DeFelice says. Additionally, the cost of taking Social Security early must be considered.
along with funds from an employer-sponsored retirement plan and taxable investments can make taking Social Security early — and potentially short-changing benefits — a less urgent need.
"Roth IRAs
can also be used for your children's
college savings goals."
— Delvin Joyce
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Roth strategies for investing can make retiring early possible.