Should I put my after-tax savings in a Roth IRA?
I have a decent sized savings account. Does it make sense to put some of this money, around $5,000, into a Roth IRA. I am looking at about 15 years until retirement and I fund my 401(k) at 10%. I was thinking that since my savings are already taxed, why not start putting them in a Roth. I will still have money left over for an emergency fund. Should I do this?
I think it would make sense. Remember, with a Roth you can always with draw your contribution penalty free/tax-free for any reason. Only earnings are subject to early withdrawal penalties. So, a Roth is a great dual purpose account. It provides emergency money if needed or long-term retirement supplement if not.
If your primary purpose is an emergency fund, open the Roth at the bank and buy a 1, 2, and 3 year CD. That way you have 1/3 of the account available every year.
If your primary purpose is retirement, look at a conservative fund, like a Vanguard Target date fund, based on your years until retirement. Or open a brokerage account and buy one or two of the dividend aristocrats and reinvest your dividends.
One thing to consider is what other goals, outside of saving for retirement, you have. A Roth IRA is a wonderful savings vehicle with a good deal of flexibility and powerful tax free growth potential. One possible problem with Roth IRAs are they may limit your optionality in the future.
While you can always withdraw your contributions to a Roth IRA, tax and penalty free, you can only withdraw the earnings from the account for specific reasons, after having the account for 5 years before age 59 ½, without facing a 10% penalty and a possible tax bill. Some of the most common exceptions are a first time home purchase, qualified higher education expenses, or some types of medical expenses.
Even though these exemptions, along with others, exist, you should think about your Roth IRA as primarily geared towards retirement savings. To the extent your 10% savings rate in your 401(k) will meet your anticipated retirement needs, it may be more beneficial for you to save dollars outside of a Roth, depending on your unique financial goals. You may also wish to consider changing your 401(k) contribution from traditional to Roth, if available to you. A Roth 401(k) is a great way to get around the income limitations placed on direct contributions to Roth IRAs.
If you have at least 3 month's worth of expenses in your savings account, it could make sense to put additional savings into a Roth IRA. Contributions to a Roth IRA don't give you an up-front tax break, but the growth is tax-free as long as you withdraw the money after you turn 59 1/2 or have the account for 5 years, whichever is longer.
There are limits to who can contribute to a Roth IRA. If you make more than $186K as a married tax filer or $118K/year as a single filer, the amount you can contribute to a Roth IRA decreases. At $196K (married) and $133K (single), you are unable to contribute to a Roth.
Hope that helps!