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Roth IRAs: A Great Tool for Investors Looking for Tax Efficiency

Diversification means more than a mix stocks and bonds: It means tax diversification, too. Roth IRAs can help with that.

One of the best things a financial adviser can do for you is provide strategies that can help preserve your assets against risk. Most commonly, people think of diversifying their investments. But it’s not enough to diversify only your investments; you should also diversify your assets in tax-efficient accounts.

The Roth IRA provides a great tool for investors looking to diversify their taxable assets. Distributions that follow IRS guidelines are completely tax-free. In the future if you face a challenging situation like higher taxes, a Roth IRA will give you the ability to draw tax-free funds and take less from taxable accounts. If you have all your money in one tax bucket, such as a traditional IRA or 401(k) — which many investors do — whatever happens down the road, you will be forced to draw from vehicles that are all taxed the same way, and your money really isn’t diversified, from a tax standpoint.

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Roth accounts such as Roth IRAs, Roth 401(k)s and Roth 403(b)s, also provide an excellent option for retirement planning. Twenty years ago, financial advisers followed the conventional wisdom that retirees would not need as much income to live off of. By that logic, retirees would be taxed at a lower rate because they are taking less income.

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But this assumption is unlikely to hold up, especially as the national debt continues to grow. At some point, the debt has to be paid back, and the easiest way to do that is by raising taxes. It’s something to keep in mind as you plan your retirement. A Roth IRA might be a good safeguard in case taxes do go up. Putting it simply, if you have a Roth IRA, because it is funded with after-tax dollars, you have a tax-free pass for your money in the future.

Another benefit to contributing to a Roth IRA is liquidity. There is one major caveat on this front: You have to pay attention to the rules for any gains or earnings inside the Roth IRA but, generally, the money you contributed can be pulled out without taxes or penalties.

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Roth IRAs are also a great tool for estate planning. Too often, when an investor with a Roth IRA passes away, his or her beneficiaries just want a check — which makes the money taxable, and that often can lead to some nightmarish tax situations. But funds inside a Roth IRA can be transferred to an inherited IRA, clearing up some of the problems that can occur, including major tax liability. This makes Roth IRAs a great legacy for your beneficiaries.

When looking at IRAs, Roth IRAs may make more sense for many investors. Unlike traditional IRAs, Roth IRAs do not have a minimum distribution, a feature that can help investors avoid tax liabilities. One disadvantage of a Roth IRA comes when you want to convert money from a traditional IRA. If done upfront, when the money will be taxed, this can be a major disadvantage. It may be a better strategy to keep money in both traditional and Roth IRAs and limit conversions between them.

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You’re never too young to start planning for your retirement, and Roth IRAs provide a good option for younger investors. All of the money put in a Roth IRA will grow and compound during your earning years. Of course, too many investors do not start their retirement planning until much later on. Even then, it’s never too late to put money into a Roth IRA. It’s not a bad option for people nearing retirement.

While they’re not the most trendy of investment options, Roth IRAs offer a host of benefits for investors of all ages and all situations. Any investor or financial adviser planning their retirement should take a look at Roth IRAs.

Kurt Supe, CPA, and Kevin Derby contributed to this article.

Kurt Supe and John Culpepper offer securities through cfd Investments, Inc., Registered Broker/Dealer, Member FINRA &SIPC, and Kurt Supe offers advisory services through Creative Financial Designs, Inc., Registered Investment Adviser. Creative Financial Group is a separate and unaffiliated company from cfd Investments, Inc. and Creative Financial Designs, Inc. Neither cfd Investments, Inc. nor Creative Financial Designs, Inc. provide legal or tax advice.

Securities Offered Through cfd Investments, Inc., Registered Broker/Dealer, Member FINRA & SIPC. Creative Financial Group is a separate and unaffiliated company from cfd Investments, Inc.

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About the Author

John Culpepper, Financial Adviser

Senior Partner and Founder, Creative Financial Group

John Culpepper is a financial adviser and insurance professional as well as a senior partner and founder of Creative Financial Group in Indianapolis. John holds a bachelor's degree in business. He began working in the financial services industry in 1997 and has acquired the kind of in-depth knowledge that comes from many years of experience guiding clients through the ups and downs of the economy.

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