No One Told Me…How Powerful a Roth IRA Is

Think for a moment about your highest-priority financial goals. What are they?  

If you’re a millennial or in the throes of your career, there’s a good chance that you want to save up for a house, need to manage student debt, and are interested in a secure, comfortable life for you and your family. Those are your top-of-mind goals. Retirement is a little further back on the horizon; it may be currently simmering on your mental back burner. And with these current financial goals, you may feel that investing is something best saved for a little later in life.  

Here’s the thing: investing in a Roth IRA (more on what that is below!) can specifically help people in your situation. The value of compound interest and investing in this type of retirement accounts means that thinking about retirement right now can have an outsized (and really beneficial) effect on your future.  

A Roth IRA can be simple, convenient, and net you the benefits of investing while allowing you flexibility now (and in the future). If you’ve been seeking the financial equivalent of a superpower, this is probably it.  

How does investing with a Roth IRA work, anyway?  

A Roth IRA is a specific type of individual retirement account that you fund now and enjoy in retirement. In this account, your money is invested, and it will grow over time. 

A Roth IRA differs from other IRAs in a few specific ways, which means that it can provide unique benefits for people who want to start investing as simply as possible. There are other types of IRAs that you can leverage, too, such as the retirement plan you may have through work; this is just an account that you own personally.  

When investing with a Roth IRA, you can tap into benefits like:  

  • Tax-free account growth and withdrawals: Although you have to contribute post-tax income, your account grows tax-free. Later, you’ll be able to access the money tax-free, too.  
  • Withdrawing contributions without penalties: Need to access cash before retirement? While it’s not always a great idea to withdraw funds early (at the very least, you’re removing contributions that could earn you money!), it can be comforting to know that in an emergency situation, you can do so without accruing penalties.  
  • Zero required distributions: The other major retirement accounts usually require that, at a certain age, you need to take a required minimum distribution – whether you want to or not. Now, that may not sound like a big deal, but what if you’d rather keep your money in your IRA (for any reason)? You may not need to pull money out of your IRA to fund your living expenses; you may wish to keep it in the account to continue growing your savings tax-free. Taking the money out could mean higher taxes, a halt to the tax-free growth, and less money inside the account – not great if you want to, say, use your Roth IRA to pass tax-free money to heirs.  

If you’ve got a limited amount of funds you’re able to invest or are worried about making that money completely inaccessible until you’re 60 (or 59.5), then a Roth IRA is a great option for you to explore.  

What’s the difference between Roth and traditional IRAs?  

Both Roth and traditional IRAs are retirement savings accounts; you fund them now, you enjoy the earnings during retirement.  

The primary difference comes down to when and how the accounts are taxed.  

With traditional IRAs, the contributions aren’t taxed upfront. This means that you get a tax deduction now, when you place funds in the account. However, there’s a trade-off: Later, when you pull from the account in retirement, you’ll have to pay taxes on the withdrawals. 

Contributions to Roth IRAs are taxed upfront – you contribute to them with after-tax income. This means that, in retirement, you can withdraw from your Roth IRA tax-free. Since you’ve already paid the taxes on that money, you never have to pay taxes on those funds in that account ever again.  

Seems simple. What are the fine-print rules?  

You’re right – it’s a little more complicated, but not by much. Here’s what you need to know when investing with a Roth IRA:  

  1. Contributing to a Roth IRA: The amount you’re able to contribute relates to your income. If you’re single and make less than $129,000 in 2022, you can contribute up to $6,000. If you’re married, file taxes jointly, and have a household income of less than ~$200,000, you and your partner may both be able to contribute $6,000. (The thresholds can change on a yearly basis, so checking updated income limits is always a good idea.)  
  1. Withdrawing from a Roth IRA: You can always withdraw the contributions you’ve made from your Roth IRA with zero tax or penalties. Withdrawing your earnings before retirement (or age 59.5) can be a little trickier, so working with an advisor is in your best interest if you’ll be withdrawing beyond your contributions.  

If you happen to make more than the Roth IRA income limits, you may still be able to contribute via the ‘Backdoor Roth’ strategy. However, for people in the above income brackets, that’s likely all you need to know about Roth IRAs to get started.  

Color me intrigued. When’s the best time to start investing with a Roth IRA?  

While, as a general rule of thumb, the best time to open a retirement account is yesterday, you’re never too old to benefit from opening a Roth IRA. To be eligible to contribute, you must have earned income; but there is no age restriction to do so. Additionally, you or your heirs can enjoy tax-free withdrawals on contributions at any time.  

The contribution deadlines for adding to your Roth IRA can also help with strategically-timed investments. You can fund a Roth IRA under the previous year’s contribution limits until the tax deadline passes. So, for example, if you haven’t quite hit the max contribution of $6,000 for 2021, you can still do so until April 18, 2022, before the contribution cycle restarts.  

(This means that – if you’re reading this in early April – the best time to open or contribute to your Roth IRA might be right now).  

Here’s How to Get Started with a Roth IRA in 4 Simple Steps 

Investing with a Roth IRA is simple. If you’re eligible, then consider the following steps:  

  1. Decide where to open your Roth IRA. You’ll need to locate a custodian (e.g., someone to take custody of your money) that you can trust. It’s also a good idea to check whether your custodian assesses any maintenance fees for activity surrounding your account – like opening it or trading within it.  
  1. Complete paperwork. You’ll need your SSN, bank details, beneficiary information, and legal ID.  
  1. Design your portfolio. Your goal is to pick investments that work with your time horizon and comfort with risk. (This can be a little tricky, so working with an experienced financial advisor is a good idea, especially if you’d rather not get too in the weeds about your investing strategy.) 
  1. Set up a contribution schedule. You may be able to make one lump contribution to your account; alternatively, you can opt for monthly installments. (You might even be able to set up automatic transfers so you don’t have to think about contributing at all.)  
  1. Keep your paperwork for tax season! If your custodian provides you with any specific tax documentation, keep it in a safe place to share with your CPA when preparing to file your taxes. Trust us: A little forethought will reduce a lot of stress during tax season!  

Your Roth IRA is a great way to set up a personal retirement account that, over decades, can result in a huge return – even for smaller investments. With the contribution limits and tax-and-penalty-free withdrawals that Roth IRAs offer, they can be an easy yet powerful way for you to start investing today.  

Interested in learning how to take advantage of a Roth IRA for your investment strategy? The team at Commas is here to help. Reach out to us today for personalized financial guidance to help you start working towards your goals today!  

 
 
 
Commas is a wholly-owned subsidiary of Truepoint Inc., a fee-only Registered Investment Adviser (RIA). Registration as an adviser does not connote a specific level of skill or training. More detail, including forms ADV Part 2A and Form CRS filed with the SEC, can be found at www.usecommas.com. Neither the information, nor any opinion expressed, is to be construed as personalized investment, tax or legal advice.