Why Roth IRAs, not Diamonds, Are a Woman's Best Friend

Ladies, put your finance hat on, and check out the Roth IRA.

Woman looking through a diamond at a Roth IRA statement.
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“What girls really need to be dreaming about is Roth IRAs, not diamonds”, says Craig Adamson of Adamson Financial Planning in Marion, Iowa, who has taught an educational workshop called “Roth IRAs, Not Diamonds, Are a Girl’s Best Friend” at a local women’s conference (Beyond Rubies) starting back in 2011. 

Craig said the idea came from watching the movie “Gentlemen Prefer Blondes” featuring Marilyn Monroe where she sings the iconic song. He was concerned that so many of his female clients either hadn’t funded Roth IRAs, or worse, hadn’t even heard of them. 

Here are the top 3 reasons Craig thinks Roth IRAs are a woman’s best friend. 

1. Accessibility

Many women do not keep a liquid savings account in their own name. Often the only account they own that is not a joint account is their 401(k) or other workplace retirement plan. But those retirement plans are not very accessible. Taxes, penalties or onerous loan fees and paperwork (if loans are even offered) keep these monies safe for retirement years, but not readily available for use today. That’s not a bad thing. Those accounts should stay put to be used in retirement. But you still need some money that is accessible for the “life happens” kind of events that you can’t plan for.

That’s where a Roth IRA comes in. Anyone (which includes women – single, married, divorced, and widowed) can withdraw their Roth IRA contributions (but not the investment earnings portion) at any time for any reason with no penalty. Yes, Roth IRAs are meant for retirement, but because you can withdraw contributions, your Roth can do double duty as your emergency fund. And the money is not held jointly. It is in your name to do with as you wish.

The reason this is possible is because you pay taxes on the money before it goes into the Roth IRA account. A basic rules of retirement investing is that any money you already paid taxes on is yours to withdraw whenever you would like.

Keep in mind if there is growth in the account you want to leave that alone until age 59 ½. You will pay regular income taxes as well as a 10% penalty for taking the growth portion out early. These taxes do not apply to the withdrawal of contributions, and due to Roth withdrawal rules, contributions are always considered to be withdrawn first.

For parents, another advantage to the Roth; money held in a Roth IRA is not subject to reporting on the FAFSA (Free Application for Federal Student Aid) for college planning. However, your contributions can be withdrawn later on (typically in the senior year of college) to pay for college tuition, room and board, etc. without being counted as a reportable asset on the FAFSA form. And, if you wait until your child (or grandchild) is out of college, the money can be withdrawn to pay off student loans they have taken out.

2. Flexibility 

Unlike a Traditional IRA, when you withdraw from a Roth IRA in retirement your withdrawals are tax-free which means you get to keep every dollar you withdraw – even the gains (as long as they’ve been there for 5 years or until you reach age 59 ½, whichever is longer).

Many purchases, like a new auto or a once in a lifetime vacation, may require more funds in one year than another. A Roth is the perfect type of account to use to pay for these extras as the withdrawals won’t increase what you owe in taxes.

That’s because unlike withdrawals from taxable IRAs and 401(k)s, Roth IRAs will not subject your Social Security to taxation. Nearly every type of income – pensions, stock dividends, tax-free bond interest, CD interest, gains on annuities - all contribute to the taxation formula for Social Security, but Roth IRA withdrawals do not. This tax benefit of the Roth can have a big impact on women, who are likely to live longer and end up filing taxes as a single tax-filer later in life.

To get more money into a Roth, women who are significantly younger than their husbands (more than 5 years, and certainly 10 years or more) should strongly consider using something called a Roth IRA conversion where you pay taxes on a Traditional IRA account and convert it into a Roth account. This strategy is often best utilized in years prior to either spouse taking Social Security. Using the Roth conversion allows you to pay taxes upfront and then may reduce or eliminate future taxes on a major source of income for widows… Social Security. 

The drawback? Whatever you convert will be subject to income taxes in the year you convert it at your normal tax rate. In other words, prepare for a hefty tax bill, especially if you're in a higher tax bracket. You don't have to convert it all at the same time. You could convert a set amount each year.

Craig, who is a member of Ed Slott's Elite IRA Advisor study group, often uses one of Ed's quotes to emphasize the value of a Roth conversion, “An IRA is an IOU to the IRS.” Ed's referring to a Traditional IRA. The wider the age gap between spouses, the more the Roth IRA tax benefits may improve your retirement situation.

A qualified financial advisor in combination with a qualified tax advisor should be able to help you determine if this Roth conversion strategy is available and practical for your situation. 

3. Longevity

Women live longer than men. We know that – but have you thought about how that impacts your taxes in later years?

Living longer means the sooner you add money to a Roth IRA, the longer it has to grow. And remember it is growing tax-free that whole time. Since there are no future taxes attached to that money, a Roth IRA becomes a financial “hedge” against higher future taxes. 

Roth IRAs are especially important to women when you factor in the effect of required distributions. When anyone turns 70 ½ they must take mandatory distributions from their Traditional IRAs and 401(k) accounts. This money is not only taxable, but the mandatory distributions may begin to make more of your Social Security benefits taxable. 

Money in a Roth IRA isn’t subject to the age 70 ½ required minimum distributions like non-Roth IRAs and 401(k)s are. So if you don’t need the money, it doesn’t have to come out of the account and can stay growing tax-free. 

Money in a Roth IRA left by a spouse to a spouse also doesn’t require mandatory distributions. However when a child inherits a Roth they will be required to start taking distributions - however all distributions are tax-free to them. Parents looking to leave a legacy gift to children or grandchildren can leave this asset to a younger heir and the non-spouse recipient can “stretch” the distributions over their lifetime, giving them a life-long stream of tax-free income.

And for those doing their estate planning, if you want to leave money to your kids and to a charity, always consider leaving the non-Roth money to the charity, as charities do not pay taxes on receipt of these types of accounts whereas your children would. In nearly all cases, you want to leave the Roth IRA money to a person not an institution. Consulting with a qualified advisor is always advised when doing this type of planning.

Getting Money into a Roth IRA

Roth IRAs have rules about how much you can contribute and who qualifies. For example, to get money into a Roth IRA you must have earned income. For women who don’t work outside the home but whose husbands do work, something called a Spousal IRA still allows contributions to be made in the name of the non-working spouse. Many spouses are not aware of this option.

For high-earning women, if you make too much you often can’t contribute to a Roth, but there is something called a “back door” strategy where you fund a non-deductible IRA and convert to a Roth. This can be a way to get money into a Roth even if you thought you couldn't contribute. Several special tax rules apply so please seek out a qualified financial and/or tax advisor to discuss your options.

You should also check with your employer to see if they allow Roth contributions to the 401(k), which is called a Designated Roth 401(k) account. If they don't, ask them to amend their plan to allow for this.

Whatever you need to do, skip the diamonds, and start a Roth IRA.