Roth IRAs: So Much More Than a Retirement Account

Investing
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By Andrew Comstock

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The Roth IRA is a popular way to save for retirement, and with good reason — its flexibility before and after retirement makes it an ideal savings method for many Americans. While saving for retirement is the best use of a Roth, there are some other options that make it a powerful lifelong financial tool.

One of the key advantages is that contributions to a Roth IRA are made with after-tax money, so you don’t have the same restrictions as a traditional IRA. You can always withdraw your contributions tax- and penalty-free.

Here are some ways you can use both contributions and investment gains other than for retirement, without paying penalties and taxes.

Saving for college

The most popular way to save for college is with a 529 plan. But a Roth IRA offers another way to contribute, because you are able to withdraw from your Roth IRA for qualified education expenses. A Roth is also a financial-aid-friendly way to save for college. The value of your retirement accounts is not included when calculating your expected family contribution, while 529 assets are reported on your federal financial aid form. So if you can sock away money into a Roth IRA, you still may be able to qualify for a generous financial aid package. A Roth account can complement your child’s 529, or be a standalone tool.

Down payment on a house

A Roth IRA can be used for a down payment on a home. You can always withdraw your contributions from a Roth, but of special interest for potential homebuyers is the “first-time homebuyer” exception. This allows you to take up to $10,000 out of your Roth, tax- and penalty-free, and you can withdraw from both your earnings and contributions. While $10,000 may not make a big dent depending on where you live, it could help with a first-time purchase. Couples can potentially double up and each take a first-time homebuyer exception. The $10,000 limit applies only if you are withdrawing earnings from your Roth.

Emergency money

If you have not established a rainy day fund or emergency fund, or you are working toward building one, and something unfortunate happens, tapping your Roth is a possible solution. While it’s not ideal financial planning, you can withdraw your contributions penalty-free to help get you out of a tough situation. The downside is that once you pull money out of a Roth, you can’t replace that money right away — you are only able to contribute the maximum of $5,500 (or $6,500 if you are over 50) each year. In other words, if you pull out three years of contributions, you will miss the potential gains and are limited in how quickly you can replace the money in a Roth. Missing tax-deferred gains can be a tough pill to swallow.

If you are pondering making any of these moves, it is important to keep good records. You will have to show how much of your Roth is contributions versus earnings. If you have moved your account around from brokerage firm to brokerage firm, the burden is on you to maintain this information.