With President Obama (and previously President Bush) considering a tax on earnings in 529 plans in an effort to close tax loopholes, we’re doing some considering of our own: seeking out new approaches to saving for college in the event that this tax is made law. The Roth IRA immediately comes to mind, not only because of its tax incentives but also for its other varied uses. Not as familiar with the broad utility of this retirement tool? Read on.
Retirement
Certainly the Roth IRA is a very popular retirement vehicle and can be used effectively as either a primary or secondary retirement source. The ideal use of a Roth is as a secondary tool to your company 401(k). Depending on your tax bracket you can contribute up to $5,500 annually in addition to your 401(k) contributions. If you’re over the age of 50 you can contribute another $1,000 per year. Also, unlike a traditional IRA, you are not required to withdraw funds from the Roth at age 70 ½ so you can allow your money to continue to grow for a potentially longer period of time. All contributions go into a Roth after taxes have been paid on them, so you may withdraw your contributions tax and penalty free at anytime. After the account has been open for five years and you are over the age of 59 ½, you can withdraw earnings penalty and tax free.
Saving for College
Using a Roth in place of a 529 plan or similar college savings plan can allow for greater future options with your child’s college education. Contributions to the Roth can be withdrawn at any time tax and penalty free, so you can decide when and how to use that portion of the Roth account. In addition to tuition and books, contributions from a Roth can be used towards college expenditures that the 529 plan does not allow (without penalty) such as rent and food. Should the timing work out, you can put all contributions and earnings tax-free towards education expenses after the account has been open for five years and you are 59 ½. Perhaps the largest benefit of a Roth over a college savings plan is that should you decide not to use the money for your child’s college expenses you will not be subjected to the additional penalties you would experience with a 529 plan. Do bear in mind that a parent’s Roth account balance is considered when a student applies for financial aid.
Saving for a Home Purchase
If you’re saving to purchase a home, open up a Roth IRA. Because contributions to a Roth are made after taxes, you can access the money you put into the Roth at any time without tax or penalty. You can also pull up to $10,000 in earnings, after the account is open for five years, for a first-time home purchase penalty free. Opening a Roth to save for a home purchase could be a good way to make your money earn more for you than it might in a traditional bank savings account through investment. Of course, when you’re investing you do add a level of risk to the growth of your contributions, making this an approach which might be too risky for some households. However, longer investment timelines and conservative investment techniques can protect against loss.
As always, consult your tax expert before taking action with any individual retirement account. If you’d like more information regarding Roth IRAs, contact us a getstarted@arkfi.com or call us at (719) 559-1919.
Photo by Hallvard E
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