Besides being a great type of retirement account that can save you thousands in taxes in the long run, a Roth IRA can be utilized as a fantastic, tax saving "emergency, college, medical, or house down payment" fund before age 59 1/2.
Not only can you invest your funds however you'd like (CDs, bonds, or stocks) in a Roth IRA, but you may not have to pay income tax or the 10% early withdrawal penalty on the earnings when you take the money out.
The IRS allows you to take "distributions" (withdrawals) from your Roth IRA before 59 1/2 without penalty or taxation of earnings if they meet the qualified early distributions rules.
But before we move on to those, there are a few basic Roth IRA rules that you need to follow to be able to open an account, make contributions, and receive distributions.
- Your modified adjusted gross income (MAGI) must be below $107,000 for single filers, and $169,000 for joint filers for full contribution eligibility in the 2011 tax year.
- You may not contribute more than $5,000 ($6,000 if over age 50) total in all IRA and Roth IRA accounts combined within a tax year.
- You must have the Roth IRA opened for 5 tax years to receive early qualified distributions.
If you fit the bill after reading these rules, you can read on to receive early distributions (before age 591/2) from your Roth IRA without the 10% penalty or taxation of earnings.
You can use your Roth IRA as:
1. A Back-up Emergency Fund
I wouldn't recommend raiding your Roth IRA if it's your sole retirement account, but if you've exhausted your current emergency fund for any reason and need cash, a Roth IRA can be used as a great back-up.
Under the IRS "ordering rules" all of your contributions to the account can be withdrawn at any time without tax or penalty. Just remember to leave earnings that you made in the account or you'll be taxed and given the 10% penalty.
2. A College Fund
Thinking about going to graduate school, traditional college or even a vocational school to sharpen your skills but can't get enough in student loans or grants? You can use your Roth IRA distributions to pay for "qualified expenses" of higher education for yourself, your spouse, your children or even your grandchildren in most cases.
The funds can be withdrawn and used without tax or penalty towards tuition, fees, books, supplies and any equipment required to be enrolled in a post-secondary school. If you're enrolled in the eligible school at least half-time, you can even use the funds for room and board expenses.
If you're just starting to save for college, consider a 529 plan or Coverdell education fund instead as those fund contributions count separately from your $5,000 IRA/Roth IRA annual limit.
3. A Back-up Medical Fund
Are you without medical insurance or do you have significant medical expenses not covered by your insurance? If you don't have an HSA or FSA to draw from, you can use Roth IRA funds tax and penalty free towards unreimbursed medical expenses if they collectively add up to more than 7.5% of your adjusted gross income (AGI).
The funds can also be used to pay medical insurance premiums (like COBRA or private insurance) if you've received unemployment compensation for the past 12 months. Your Roth IRA can even be tapped without repercussions in the event that you become seriously ill or permanently disabled.
4. A First-Time Homebuyer Down Payment Fund
This is the most popular alternate use of a Roth IRA and can potentially save you thousands in taxes when it's time to buy your first home. You may also qualify for this if you haven't lived in your current home for more than two years.