What is a Roth IRA and How Does It Work

Preparing for retirement can be stressful. And you may be wondering how you can possibly meet your lofty goal of retiring by the age of 37. The good news is that the government offers several tax-advantageous retirement plans. Which you can use strategically to help you prepare for this future stage in your life. After you ask what is a Roth IRA and you learn how it can benefit you, may be ready to take full advantage of this resource.

What Is a Roth IRA?

The first step to take when exploring tax advantageous accounts is to ask what is a Roth IRA. A Roth IRA is a special type of retirement account that can better help you to prepare to retire by the age of 37 because it uses taxed money as contributions, and it allows you to pull money out at a later date that is tax-free.

If you are under the age of 50 years old, you can contribute up to $5,500 per year currently into this account. The funds that you contribute into the account are taxable, but the growth is not taxable. Furthermore, when you pull the money out of the account later in your retired years, it will not be taxed by the government. This means that your tax liability in retirement can go down dramatically.

You may be wondering how an account that allows you to take funds out tax-free after the age of 59 years old will help you to retire by the age of 37. Most people who plan to retire earlier in life will have an income stream that they rely on now, such as through dividends or real estate rental income. Then, they will have a second stage of their plan provide them with additional income later in life. Because this second stream of retirement income will not be taxed, you can better manage your budget.

Reasons to Start a Roth IRA

After you ask what is a Roth IRA, you may be wondering what the top reasons are to start a Roth IRA today. With a closer look at the answers, you may be ready to open and fund your account soon.

You May Be Able to Retire By the Age of 37

Your primary retirement goal is to retire by the age of 37. And you need to take full advantage of every opportunity available. Because the income stream that you set up now for your earlier years in retirement may be taxable, you need the second income stream that kicks in later in life to be non-taxed. When you fund your Roth IRA now, you can enjoy this strategic setup. And you can ensure that you have a well-funded second stream of retirement income later.

You Can Limit Tax Liability in Retirement

When you fund retirement accounts and expect to receive additional income from non-retirement income streams, there is a good chance that your tax liability in retirement will be very high. When you learn what is a Roth IRA, you will see that this is a great option for you to reduce your tax liability. You may be able to draw thousands of dollars or more per month from this account. All without paying income taxes on it and without it affecting your tax bracket. This can save you a fortune later in life.

You Can Convert Your 401(k) Into a Roth Account

Some people think that they cannot qualify for a Roth IRA because they earn a high level of income. It is true that the government limits who can contribute to these accounts, but there is a back door. You can contribute funds to a 401(k) account, and convert the account to a Roth IRA when you are ready. This is an exceptional way to maximize the benefit of an account that you may not otherwise qualify for.

Withdrawals Are Not Taxed for Your Heirs

While you may still be very young, it is beneficial to plan ahead for your passing. Your Roth IRA funds can be left to your heirs. And they can continue to receive tax-free withdrawals from the account when you are no longer living. This is a great way to keep their tax liability as low as possible.

Benefits of a Roth IRA

When you ask what is a Roth IRA, you may be wondering what the benefits of this type of account are. And how you can maximize them to your advantage. The benefits of a Roth IRA are numerous, and these are among the top benefits available to you.

The Ability to Retire at a Very Young Age

Because you plan to retire by the age of 37, you need a retirement account that is going to help you meet that goal. While your contributions made into the Roth IRA use taxed income, the money will grow without being taxed. This gives you the great opportunity for your funds to grow more substantially over time. You can make trades as desired to maximize the value of your portfolio without worrying about the tax liability.

Penalty-Free Withdrawals Earlier in Retirement

Some people who plan to retire early do so with taxed income streams in place, such as through dividend-producing stocks. This is because most retirement accounts require you to pay a rather high penalty if you take the funds out before you reach retirement age. However, with a Roth IRA, you can take out the funds from the account at any time without penalty. You may still have to pay tax on the growth if you take the growth of the funds out before the age of 59 and a half. But you will not have to pay the hefty penalty.

Easier Budgeting in Retirement

When you are preparing your retirement budget and trying to plan for the future, tax liability may be a big question mark. After all, the government is constantly changing tax brackets, credits, deductions and more. However, this can account for 10 to 20 percent or more of your expenses. When you use a Roth IRA to generate tax-free income in retirement, you eliminate this factor from the equation. This makes it easier for you to more accurately prepare for retirement.

Keep Contributing Funds to the Account

Another great benefit that you can enjoy after learning what is a Roth IRA is that you can continue to contribute funds into the account after you reach age 70 and a half. You still have 20 to 30 years of life to live at this point. And you understandably need your funds to continue to grow and accumulate in value during this time. With a Roth IRA, you can contribute extra funds from other sources of income into this account. And you can enjoy using the tax-free money at the very latest stages of your life.

As you can see after you ask what is a Roth IRA, this is a special type of tax-advantageous account that you can benefit from in many ways. A Roth IRA is most commonly used by individuals who plan to have a higher income level in retirement than they do right now. If you think that this type of account may be advantageous to you, there is no better time than right now. Open your account and start maximizing your contributions to it.

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