Use Your Roth IRA to Reduce Your Tax Liability

Put your Roth IRA to work for you

A Roth IRA is an individual retirement account that offers a valuable future tax break – tax-free income in retirement. A Roth IRA can also be tapped for much needed income when your child goes off to college or something sooner, like your first home. Roth IRA distributions are tax-free when you follow the rules. This is because every dollar you put in a Roth IRA is your money, not a tax-subsidized gift from the government. This enables you to tap your contributions (but not your earnings) any time, tax-free and penalty-free.

Use a Roth IRA to Save for College


Yes, the “R” in IRA does stand for retirement, but since you can withdraw contributions at any time tax-free and penalty-free, the account can serve as a terrific tax deferred college-savings plan. Let’s assume that you and your spouse put $2,500 in a Roth plan the year your child is born. If you keep this up for 18 years then the dual Roths would hold about $206,000, assuming 8.25% annual growth. Up to $90,000, the total of your contributions can be withdrawn tax-free and penalty-free and any part of the interest can be withdrawn penalty-free, too, to pay for college.

Fund a Roth IRA for your child or grandchild


As soon as your child or grandchild begins to earn money, they can have an IRA. Grass cutting, baby sitting or any income from a job will qualify them to start an IRA. Your child or grandchild’s own money doesn’t have to be used to start or fund their IRA.  Not too many young workers are going to want to start saving for their retirement anyway, so a generous parent or grandparent can provide the funds. They can be creative as well and encourage the young worker by matching any funds that they can save as well. This will encourage and help them with the right frame of mind to start saving and the long term tax-free growth can be staggering as well. 

Use that Roth IRA to save for that first home


A Roth IRA can be a powerful tool to help save for that first home. Money that is put away or taken out of your paycheck before you see it or spend it is missed less. In a short period of time, you could amass enough to cover  the closing cost of your first home. All contributions can come out of a Roth IRA at any time, tax-free and penalty-free. After the account has been opened for five years, up to $10,000 of earnings can be withdrawn tax-free and penalty-free for the purchase of your first home. Let us assume you can put away $5,000 a year for 5 years into a Roth IRA. After 5 years, you would have $25,000 in contributions and with 8% in growth, the total Roth IRA value is $31,680. All of this amount could be withdrawn tax-free and penalty-free for the purchase of your first home.


Convert to a Roth IRA


If you are considering switching a traditional IRA to a Roth then you will be required to pay the tax on the converted amount. This, however painful now, can be a fabulous tax saving investment for the future, because all of the future earnings of the Roth IRA are tax-free in your retirement. You have a narrow window once the conversion takes place if the Roth IRA investments take a turn for the worse. You have until October 15 of the year following the conversion to “unconvert” and avoid paying tax on the money that was lost. You could, if desired, re-do the conversion in the following year.

Your Roth IRA is not just a retirement plan but can be a good way to save for other expected expenses. You can take advantage of the tax laws and use your Roth and traditional IRAs to take full advantage of the tax code. At garvey & garvey, LLC CPAs, we can easily assist business owners and employees with establishing a method that is appropriate for them so that there are no unwelcome surprises when the tax year ends.