What’s the big deal about a Roth IRA?
Okay so I had heard the term Roth IRA from time to time but I didn’t really understand or know what it was. It was just one of those financial terms that was tossed around. I already had a 401K so why did a Roth matter? If only I had understood the power of the Roth in my younger days! Once I was enlightened about this magical math money-making machine I immediately opened one up and started maxing my Roth out every year since.
A Roth IRA is an individual retirement account that is funded with after tax dollars (unlike a traditional IRA or 401K where the money is put in pre-tax). This can make a HUGE difference in the amount of money you earn over time. The reason is because the money you put into a Roth grows TAX FREE! Anytime you can keep more of your money out of the hands of the government the better, so this is a fantastic option for doing so because the majority of the money in a Roth is growth as long as you started contributions early on.
Who can contribute?
There are some limits that you need to be aware of in order to contribute to a Roth IRA however. First, as of writing this, you can only contribute a total of $5,500 per year to a Roth. Since it’s an individual retirement account, if you are married, both you and your spouse are able to each contribute that amount so essentially it comes out to $11,000 for the both of you.
There are also income limits. You cannot contribute to a Roth IRA if you are single with an adjusted gross income (AGI) of $120,000 or more. If married filing jointly you cannot contribute if your combined AGI is $189,000 or more. If you do happen to make more than that congratulations because you’re killing it with the high income! But don’t fret, even you can still do what’s known as a “backdoor Roth IRA” where you contribute to a traditional IRA, then rollover the funds into a Roth IRA. But for most of us, if you make less than those thresholds then you are able to directly contribute to a Roth IRA! Oh, and if you are over 50 you are allowed to make an additional $1,000 catch up contribution each year!
If you are already contributing to a 401K, 403b, or 457 then you are still eligible to contribute to a Roth IRA. It’s a great way to boost your investments by being able to contribute to multiple retirement accounts.
When can the money be taken out?
Since it’s a retirement account you can begin taking withdrawals at 59 1/2, however unlike a traditional IRA or 401K there are no required minimum withdraws so you could essentially keep the money in the Roth IRA forever and pass it onto your beneficiaries at which time they are required to take small mandatory withdrawals. There is however a way to withdraw your money earlier and that’s if you leave your company at age 55 or older than you are eligible to begin withdrawing instead of waiting until 59 1/2.
With the Roth IRA since you already paid taxes on the money you are able to withdraw whatever amount you contributed without any taxes or penalties. Some people actually use a Roth IRA account as their emergency fund because of this. This means that if you had put in $2,000 a year for 10 years you would be able to withdraw up to $20,000 at any time, you just can’t withdraw any of the earnings until you’re 59 1/2 and have held the account for at least 5 years (otherwise there are penalties that go along with that). It’s a much better alternative than taking it out of your 401K because of the taxes and penalties that go along with early withdrawals from those accounts. But I’d still advise to not touch any retirement accounts because you are unplugging from potential growth and there are some serious drawbacks to doing so.
How do you get started?
It’s actually really simple to get started. Roth IRA’s can be opened through almost any banking or financial institution. You can call over the phone or you can even set one up online from the comfort of your own home right now, seriously like right now, do it now! If you already have a financial advisor they can set you up with one as well. Find what suits your investing needs best, just be careful to avoid high fees and transaction costs. I personally recommend setting up a Roth through either Vanguard, Fidelity, or Schwab because of the low fees (overtime this can save you thousands upon thousands of dollars-just check out this article on how) and this can all be done online.
The minimum amount required to open a Roth IRA is usually pretty low considering the max you can contribute is $5,500. Some places do not have a minimum requirement in order to open a Roth so just check around to see. You can contribute the $5,500 in one lump sum or you can do it monthly which if you are going to max it out would be around $458 each month. You can set up automatically monthly payments so that when you get paid the money gets transferred automatically. And if you can’t afford to max it out that’s totally okay! Any amount put in is better than none at all! Start slow and increase over time.
Upon opening the Roth IRA you will select which investment options you’d like, typically individual stocks, bonds, and mutual funds. If you’re unsure of how to allocate your investments they do have target date funds set up that will typically be a mix of stocks with some bonds, increasingly moving into more conservative funds as you get closer to retirement. I personally have my Roth through Vanguard in the total stock market index fund (VTSAX) because it has extremely low fees and it seeks to track the performance of the US stock market. It’s passive investing and is one of the top mutual funds by assets. In the early retirement community it’s also a top pick for investing and by far one of the most popular funds to stash your cash.
The golden ticket
One of the great things about a Roth IRA is that anybody can contribute as long as they have earned income. For kids and teens this is an absolute gold mine. For example, if you have a teenager who mows lawns during the summer and earns enough money to file a tax return (doesn’t mean that they will pay taxes but as long as they file taxes) they are eligible to contribute to a Roth. Let’s say that kid puts in $2,000 every year into their Roth IRA they would have over $1.2 million dollars by the age of 65! Now imagine if they were able to max it out at $5,500 they would have over $3.4 million dollars, assuming an 8% rate of return! Say whaaaat!!! That’s with no other investing or retirement accounts! Talk about a good nest egg!
I recently heard a podcast episode where a couple started a Roth IRA for their baby (yes, baby) who was paid to be in a commercial and they were able to max out this baby’s Roth before it was even 1 year old. That’s over $750,000 by the time that baby turns 65, and that’s with not contributing one more dollar to that account, only having invested the original $5,500! That’s some serious growth that is all tax-free!
The best thing you have in your corner with investments is time and time is money in this scenario. Start early and you will reap the rewards. Even if you are older the best time to start is now, it’s never too late to contribute! If you are close to retirement age then a Roth may not be the best option tax wise for you but if you still have many years to go then definitely look into getting a Roth. Jump online and google “Roth IRA calculator” to see just how much money you could have at retirement if you started contributing to one today!