You cannot pick up a single personal finance periodical, or read a single personal finance blog, without finding at least one mention of the Roth IRA. And for good reason! The Roth IRA is known by most associated with the world of finance as the ultimate retirement vehicle. While there are advantages and disadvantages to funding an early retirement with a Roth IRA, there is little doubt it should at least be part of the mix.
Advantages of the Roth IRA
Roth IRA contributions are made with after-tax dollars, and earnings on the money grow tax free over the life of the account. At retirement age, currently 59 1/2, earnings may be withdrawn tax free. Contributions to a Roth IRA may be withdrawn at any time without penalty. For this reason, it makes sense to keep track of your contributions each year so you are able to differentiate between earnings and contributions when withdrawals are made.
In a few very specific cases, earnings held in a Roth IRA longer than five years may be withdrawn without penalty. These scenarios for penalty-free withdrawals from a Roth IRA are well-document elsewhere, but include things like death or disability of the Roth IRA owner, repayment of back taxes levied by the IRS, or towards the purchase of the account owner’s first home.
Roth IRAs and the Early Retireee
The only real drawback to using a Roth IRA to invest for an early retirement is that earnings cannot be tapped until age 59 1/2. That is great for those who plan to retire in their 60s, but for those of us planning an early exit in our forties or fifties, it presents a problem. Of course, there are other options available, such as investing outside of retirement accounts to be used from say age 45-60, or tapping contributions early while earnings continue to grow until retirement age.
I think the former strategy is the one we will employ-invest above the Roth IRA (and our 401k) in low-turnover, non-retirement accounts such as index funds, individual stocks with high dividend yields, and cash-based investments. These investments outside of our retirement accounts should help us “float” from early retirement to tradition retirement age, where we will then have our Roth IRa and 401k balances available.
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