Like the kitchen gadgets advertised on late-night TV that can slice, dice and turn radishes into roses, the Roth individual retirement account is an amazingly versatile product. Its primary purpose is to provide a tax-advantaged way to save for retirement. But unlike other retirement-savings accounts, Roths let you use the money for a variety of purposes without triggering crippling taxes or early-withdrawal penalties. Investing in a Roth won't reduce next year's tax bill because Roths are funded with after-tax dollars. The payoff comes later. Once you're 59 1/2 and have owned the Roth for at least five years, withdrawals are tax- and penalty-free.
That makes Roths particularly attractive for young workers. If you're just starting out, you're probably in a low tax bracket, which makes the upfront tax savings of a deductible IRA less valuable. A Roth, however, promises decades of tax-free earnings growth. And if you find yourself in a much higher income tax bracket when you retire, your tax-free withdrawals will be all the more valuable.
Once you invest in a Roth, you should leave the money alone until you retire. But if you need money in a pinch, you may withdraw the amount of your contributions at any time, for any reason, without paying taxes or penalties.
If you withdraw earnings from your Roth before age 59 1/2, you'll usually pay taxes on that money, along with a 10-percent penalty. But if you've owned the Roth for at least five years, you may withdraw up to $10,000 in earnings for the purchase of a home without paying taxes or penalties. Plus, your contributions come out tax- and penalty-free even before you begin to tap into earnings. If you tap your Roth to pay for a child's college costs, you'll owe taxes if you dip into earnings, but you'll be spared the 10-percent early-withdrawal penalty.
Roths also offer estate-planning benefits for older savers who have other sources of retirement income. With traditional IRAs, and generally with 401(k) plans, you must take annual minimum distributions once you turn 70 1/2. But Roths have no required withdrawals, so you can allow the account to continue to grow tax-free for your heirs.
(Sandra Block is a senior associate editor at Kiplinger's Personal Finance magazine. Send your questions and comments to firstname.lastname@example.org. And for more on this and similar money topics, visit http://www.Kiplinger.com.)