This Is a Really Bad Reason to Open a Roth IRA
When it comes to saving for retirement, you have choices. You could open a traditional IRA and enjoy a tax break on the money you put into that account. Or, you could open a Roth IRA and forgo an initial tax break, but enjoy other benefits down the line.
Roth IRAs allow the money you invest to grow tax-free, and withdrawals in retirement are also tax-free. That could, in turn, alleviate a world of financial stress during your senior years.
Roth IRAs are also the only tax-advantaged retirement plan to not impose required minimum distributions. With all other retirement-specific accounts, you must remove a portion of your savings each year once you turn 72 or otherwise face a steep financial penalty. But Roth IRAs let you keep your savings intact so you can keep enjoying tax-free gains in your account, and also, so you can leave money behind to your heirs as you see fit.
But while there are plenty of perks that Roth IRAs have to offer, you don’t want to open one for the wrong reason. And if you offer a Roth IRA because it’s easy to pull money out of that account ahead of retirement, then you could end up doing yourself a major disservice.
The downside of too much flexibility
In addition to tax-free investment gains and withdrawals and the absence of required minimum distributions, another benefit that Roth IRAs have to offer is that you can withdraw your principal contributions at any time without penalty. The logic is that since you don’t get a tax break on the money you put in, you’re not penalized if you pull money out ahead of retirement. With other retirement plans, you face penalties if you remote funds prior to age 59 ½.
Now to be clear, if you touch your Roth IRA gains early, penalties could ensue. Say you put $10,000 of your own money into an IRA and over a few years, that balance grows to $15,000 thanks to your investments. If you decide to take an early withdrawal from that account, that first $10,000 is fair game, and you won’t be penalized for accessing it. It’s when you try to withdraw that $5,000 in gains that penalties could come into play.
At first, having that flexibility may seem nice — so nice that you’re tempted to open a Roth IRA for that reason alone. But remember, the money in your retirement plan is supposed to be earmarked for — wait for it — retirement. If you withdraw funds early, you’ll have less money on hand during your senior years, when you’re apt to need it the most.
As such, if you can’t trust yourself to not tap a Roth IRA early, you may want to save your money elsewhere. Taking an early withdrawal from a traditional IRA, for example, will result in a 10% penalty. And that alone might motivate you to avoid accessing that cash before you’re supposed to.
Make the right call
Roth IRAs are an extremely useful long-term savings tool. But if you aren’t confident you won’t abuse that flexibility, then it could pay to save your money elsewhere. That way, you’re more likely to enter retirement with the cash reserves you need to live comfortably, and you’re less likely to fall victim to temptation along the way.
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