For most of my adult life the term “Roth IRA” was one of those things that I would hear people mention, and I would nod knowingly, pretending I knew what it was when I actually had no idea.
Which is unfortunate, because while I was busy looking at the Walgreens sales flier trying to save 50 cents on toothpaste, I was ignoring something that could have earned me thousands more dollars for retirement.
It’s too late to tell my 30-something self about Roth IRAs, but I can tell you, my dear readers!
What is a Roth IRA?
A Roth IRA is a retirement account that anyone with earned income can open, as long as your “Modified Adjusted Gross Income” (basically your taxable income) is below $153,000 for a single person, and $228,000 for a couple.
(If you are above those income levels, Google “back door Roth IRA”.)
It doesn’t matter if you already have a 401(k), if your job has a pension plan, or if you are a solo entrepreneur or small business owner. Anyone below those income levels can create a Roth IRA.
What’s so special about a Roth IRA?
Roth IRAs are unique for a lot of reasons:
1. When you withdraw the money, you don’t pay any taxes.
This might not sound like a big deal now, but trust me, when you are retired you will appreciate having a pot of money you can draw from tax free. It lowers your overall taxable income, and may also lower the amount of taxes you will have to pay on Social Security.
2. You don’t pay ANY taxes on the earnings.
This probably sounds like the same thing as point one, but contributions to your Roth IRA are “post tax”. This means that you contribute using money you have already paid taxes on – i.e. from your paycheck. But you never pay any taxes on the money you earn.
- Example: At age 35 you put $5,000 in a Roth IRA. At age 65, assuming you invested in something with 9% average returns, this will be worth $66,338. You paid taxes on the initial $5,000, but you will pay NO taxes on the $66,338 when you withdraw it. Amazing!
3. You can withdraw your contributions at any time.
Once the account has been open for 5 years you can withdraw your contributions (not the earnings) at any time tax and penalty free. This is different from other retirement accounts where you can’t touch any of the money without penalties until age 59.5.
This means that if you are worried about tying your money up in a retirement account when you might need it for something else, like starting a business or a down payment on a house, a Roth IRA gives you some flexibility.
(There are also some special circumstances where you can withdraw the earnings, not just the contributions, before age 59.5, such as for a first home, large medical expenses, education expenses, adoption expenses, or if you become disabled.)
4. You can leave the money in as long as you want
With a 401(k), after age 72 you are required to start withdrawing the money. This is called a “Required Minimum Distribution” or RMD. With a Roth IRA you can leave it invested as long as you want. This is great if you want to pass it on as a tax-free inheritance, or just keep it invested for your later retirement.
The bad news …
The bad news is that the maximum that you can contribute to a Roth IRA is $7,000 per year ($8,000 if you are over 50). Yes, that is the main downside, the fact that you can’t contribute more!
It also doesn’t lower your taxable income right now, and you likely won’t get any kind of employer match for your Roth IRA like you might for a workplace 401(k). That being said, some workplace 401(k) plans are now offering a Roth IRA inside their 401(k) plan—so it is possible!
Remember, you still have to invest the money!
Almost all brokerage firms, banks, and investment companies offer a Roth IRA, but a Roth IRA is not itself an investment, it is just a type of retirement account. Once the money is in your Roth IRA, you then have to choose an investment or investments. You can make that choice on your own, you can get guidance from the investment company, or you can go to a licensed Financial Advisor.
To learn even more about all the ins and outs of a Roth IRA, check out this very comprehensive article at Investopedia.com.
As a financial coach I cannot give specific investment advice – but I can show you how to budget and save so that you HAVE money to put into a Roth IRA. I offer affordable coaching packages as well as a free 30-minute initial consultation. All coaching is done via video call, and I do not sell any type of financial product. Schedule a call today and let’s talk!
