1. Money

Why a Roth IRA Should Be a Tool In Your Investment Portfolio

Four Reasons You Should Open a Roth IRA As Soon As You Can

By

Why a Roth IRA should be part of your investment portfolio

Why a Roth IRA? There is virtually no other account type available anywhere on Earth today that lets you shield 100% of your dividends, gains, rents, and other profits from taxation, as well as offering a hope of protection during bankruptcy.

Peter Cade / Iconica / Getty Images

One of the most frequent questions I receive is, "Why a Roth IRA?  What makes it so special?".  We've discussed the benefits of using a Roth IRA in the past but in this article, I am going to break down the four fundamental reasons using this unique type of account to hold your investments - be they stocks, bonds, mutual funds, real estate, or other securities - can make the process of building wealth much easier than it would be were you to hold the exact same assets through a regular brokerage account.

1. A Roth IRA Is the Perfect Tax Shelter for the Middle Class

If you are a member of the middle class who qualifies for one, a Roth IRA is about the most perfect tax shelter you will ever experience.  Although there are some limitations - for example, you should never hold municipal bonds in a Roth IRA - the beauty of a Roth IRA is that almost all investments held in them are completely free of taxes.  Provided you follow the rules, that means no capital gains taxes, no dividend taxes, no taxes on your interest income, and no taxes on the rents generated from real estate or REITs.  

To give you a real-world example, I know an older investor who holds roughly $1,000,000 worth of bonds.  He collects approximately $50,000 per year in interest income on these bonds, and is forced to give the government roughly $17,500, leaving him $32,500.  If he had been holding that same investment in a Roth IRA, he could have generated the $50,000 in interest income inside of the Roth itself, and then taken a tax-free distribution, keeping the entire $50,000.  That is an extra $17,500 in liquid cash that he can shove in his pocket to spend, give to charity, pass on to friends and family, or reinvest.

For someone still in their working years, especially someone who is young and just coming out of high school or college, the advantages are even larger and can have an enormous influence on the total net worth that is ultimately enjoyed during retirement.  Picture going through your life and avoiding all taxes on your investment gains, freeing every penny to fund more investments that, in turn, generate more money.  You cannot hope for a better scenario.

2. It Is Much Easier, and Less Painful, To Access Money Held In a Roth IRA

You should never have to tap into your retirement money early.  If you do, however, the damage can be severely minimized if you reach into a Roth IRA compared to being forced to reach into a Traditional IRA or 401(k) plan.  First, with a Roth IRA, you can withdrawal your past contributions without any penalty, whereas with the other types of retirement accounts, you are going to have to pay income taxes on the money, leaving you with a small fraction of what you would have otherwise had.  Second, a Roth IRA also has a myriad of exemptions that can help you avoid the 10% early withdrawal penalty, including using some of the funds to buy your first home or to pay for a medical emergency.

3. A Roth IRA Is Nearly Effortless to Administer and Can Often Be Opened for Little to No Cost

A Roth IRA is just a type of account.  It itself isn't an investment.  You can fill it with most major asset classes and virtually all discount brokers are willing to let you open an account for only $100, $250, or $500 with little or no fees.  You still need to be careful and make sure that you pay attention to the costs of the actual investments you put into the Roth IRA, such as the mutual fund expense ratio, but the account itself should be dirt cheap.  

There are almost no requirements for the Roth IRA beneficiary to deal with, such as paperwork or maintenance; nearly everything is handled by the broker with whom the account is entrusted.  

4. A Roth IRA Might Provide Asset Protection In the Event of a Bankruptcy or Financial Disaster

Now that the United States has switched away from pension plans to 401(k) plans, Roth IRAs, Traditional IRAs, SEP-IRAs, Simple IRAs, and other self-managed retirement solutions, bankruptcy courts have been very hesitant to ruin a person's future retirement during a bankruptcy filing.  You have a fairly decent chance of protecting your nest egg if you lose everything, provided it is held in a Roth IRA or comparable account.

That's huge.  It may not seem like much, but if you find yourself in the almost unthinkable position of waking up and discovering you owe hundreds of thousands of dollars in medical or legal bills, knowing that the money you saved for decades will still be there, in all likelihood, during your golden years can provide at least a small modicum of peace of mind at a time when your financial world would be collapsing.

©2014 About.com. All rights reserved.