Hacking Your Roth IRA

You know the often-suggested retirement savings checklist:

1. If your employer offers a 401(k), contribute enough to get a match.
2. Max out a Roth IRA if you qualify.
3. Go back to your 401(k) and work toward contributing the maximum of $19,500 per year for 2021.

Generally, you fund these accounts for the long-term, because early withdrawals can lead to penalties. But here’s why I love Roth IRAs so much: you can withdraw money penalty- and tax-free for specific reasons, making it more than just a retirement account.

A Quick Roth IRA Primer

In order to lifehack your Roth IRA, it helps to understand how they work. You can contribute up to $6,000 per year. You don’t have hand over that sum all at once — you can set up smaller recurring contributions, too.

Unlike a 401(k) or traditional IRA where you make contributions with pre-tax dollars, Roth IRA contributions are after-tax. That means that when you withdraw your money in retirement, you pay no taxes on it, because you already paid taxes upon contributing.

This is really helpful for young professionals who are in lower tax brackets now, but might be in higher tax brackets when they’re older and withdrawing money.

You can withdraw your contributions tax- and penalty-free at any time for any reason. Roth IRAs have a five-year rule for investment earnings and conversions: if you leave your account open for at least five years, you can withdraw that money tax- and penalty-free, too.

You can withdraw your contributions tax- and penalty-free at any time for any reason. This opens up a few possibilities for your Roth IRA in addition to saving for retirement. Here are a few other ideas of how you might want to use the funds, even though you technically can use them for anything!

Saving for College

After five years, you can withdraw your contributions tax- and penalty-free to pay for educational expenses for yourself or your kids. You’re also allowed to withdraw your earnings penalty-free, though you’ll need to pay income tax on them.

Many people immediately think of 529s for college savings, and they’re a good choice for many families because you can save above and beyond what you can save in a Roth IRA.

But Roth IRAs offer additional flexibility, especially since you can just leave your money it in the account to withdraw later in retirement if you don’t need it to pay for college. If you qualify for a Roth IRA and aren’t maxing it out, do that first before starting a 529 Plan for college.

One huge benefit is that money in your Roth IRA isn’t counted toward estimated family contributions for college (unlike 529s, which are). This could potentially lead to a more generous financial aid package, which is especially helpful for middle-income families.

Remember, you can’t take out the earnings, so if the account has grown, those earnings continue to grow tax-free in your Roth IRA and can be used to fund your retirement.

Buying a Home

You and can withdraw up to $10,000 of your investment earnings (in addition to any amount of your contributions) without paying taxes or penalties if you’re a first-time homebuyer. If you’re married, your spouse can withdraw the same amount. This money can be applied toward the down payment or closing costs.

A (Back Up) Emergency Fund

If you’re dealing with a difficult situation that has wiped out your emergency savings, your Roth IRA contributions can provide additional funds. I don’t think you should plan to use this as a cash reserve, but if you’ve been out of work for awhile or you’re swimming in medical bills, this is where a Roth IRA could come in handy.

While you don’t want to tap into your Roth IRA too easily, it can prevent you from having to rack up credit card debt to afford an unexpected expense.

Leaving Money to the Next Generation

Unlike 401(k)s and traditional IRAs, Roth IRAs don’t have required minimum distributions. That means there is never a time when you must withdraw money from your account. This makes your Roth IRA a good way to save money to pass on to heirs — without paying additional taxes on that money.

It’s really important to designate beneficiaries on your account because it prevents your assets from being tied up in probate before being distributed to heirs. Reevaluate your beneficiary list after any big life change like marriage, having a kid, or getting divorced.

Your beneficiaries will have to make a withdrawal of that money each year, but they won’t need to pay taxes on that money. The exception to this is if your spouse is the beneficiary — they’re the only one who wouldn’t be required to withdraw money each year.

Use Your Roth IRA Today — With an Eye Toward the Future

The different ways you can tap into your Roth IRA make it a flexible way to save for major financial goals. But before you withdraw money now, map out your long-term goals and get a sense of how much you need to save to meet them. Using your Roth IRA contributions today means there’s less money invested that will grow between now and your retirement.