Roth IRAs have been around since the late 1990s, but many people are still learning about the tax advantages. Because of those benefits, Roth IRAs are often a good idea if you think you're going to pay a higher tax rate when you retire than when you make the contribution.
One way to take the guesswork out of how much taxes will take out of your retirement savings is to contribute more to a Roth IRA. A huge tax advantage of contributing more to a Roth IRA is that all qualified distributions are tax-free. Qualified distributions require you meet two criteria: you must have the Roth IRA open for five years and that you be 59 1/2 years old, permanently disabled or using no more than $10,000 for your first home.
Another significant tax advantage is that all the money grows tax-free in the Roth IRA. The sooner you get your money in the account, the sooner you can take advantage of the tax-free growth (and eventual tax-free distributions). The tax-free treatment applies no matter what you invest the money in, including stocks, bond, interest-bearing notes or rental properties. Especially in years that you're in a higher tax bracket, this can save you a lot of money.
Retirement Savings Credit
Contributions to a Roth IRA may qualify you to claim the retirement savings credit. The retirement savings credit is available to people who are over 21 years old, are not full-time students during five or more months of the year, are not claimed as a dependent on another person's tax return and whose income doesn't exceed the limits based on filing status. The credit ranges between 10 and 50 percent of your contribution, with a maximum credit of $1,000 ($2,000 if filing a joint return).
Penalty-Free Withdrawals of Contributions
You don't plan on taking money out of your Roth IRA before retirement, but emergencies happen. With a Roth IRA, you can remove all of your contributions at any time without having to pay any taxes or penalties. Granted, you've already included the contributions in your taxable income. However, not having to pay an early withdrawal penalty is a big benefit. However, if you take out more than you've contributed, your earnings are taxable and subject to the 10 percent additional tax.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."