Founded in 1997, a Roth IRA is named after former Delaware Senator William Roth. It’s simply an individual retirement account (IRA) that permits tax-free withdrawals is called a Roth IRA.
As with traditional IRAs, Roth IRAs are qualified retirement plans. However, what separates these accounts the most is how they’re taxed. Additionally, Roth IRA contributions aren’t deductible since they’re funded with after-tax dollars. When you withdraw the funds, though. they’re tax-free.
There are several ways to fund a Roth IRA;
- Regular contributions
- Spousal IRA contributions
- Transfers
- Rollover contributions
- Conversions
Note that Roth IRA contributions must always be made in cash, including checks and money orders. But, securities or real estate cannot be contributed. Roth IRAs also provide a variety of investment options, such as mutual funds, stocks, bonds, ETFs, CDs, and money market funds once contributions are made.
For 2021 and 2022, Roth IRAs and traditional IRAs both limit the amount you can put into your account each year to $6,000, or $7,000 if you’re over 50.
A few conditions, however, apply. High earners aren’t eligible for Roth IRAs. Roth IRAs aren’t available to people earning more than $140,000 per year, or $208,000 per couple.
In contrast, once you’ve placed money in your Roth IRA, you’re able to keep it there. With traditional 401(k)s and IRAs, the tax authorities get their share at 72-years-old. With Roth IRAs, you can keep these funds untouched until your death.
Roth IRAs can only hold earnings. Rent, capital gains, stock dividends, interest from loans, and proceeds from another retirement fund cannot be deposited. It must be money you’ve earned through work.
Why Does a Roth IRA Rock?
I’ve alluded to some of the benefits of Roth IRAs. But let’s look deeper into why you should consider a Roth IRA as a retirement savings method.
1. The money can grow and be withdrawn tax-free.
Again, Roth IRAs can only be funded with after-tax dollars. As such, there’s no tax deduction as there is with traditional IRAs.
Also, if the investments grow or earn funds, and if you decide to take distributions in retirement, these earnings and growth are tax-free. In fact, these may also be tax-free from state and local taxes. The catch, though, is that you must meet certain conditions.
2. Easy access to funds early.
If possible, you should keep the money you’ve stashed for retirement hidden away and untouched until retirement. But, what if you are in financial trouble and need to tap into these funds? No problem.
You’ll likely have to pay income tax and a 10% early withdrawal penalty if you withdraw from a traditional IRA before age 59 ½. But, as long as the money you withdraw isn’t derived from your earnings but rather from your contributions, you can avoid paying both taxes and penalties. As a result, this makes a Roth IRA a solid emergency fund option.
Moreover, a Roth IRA offers better returns than a savings account. The downside is that your investments could lose value. As a rule of thumb, don’t combine emergency savings with retirement savings.
3. There are no required minimum distributions.
“Roth IRAs offer unique benefits at the other end of the investment story, too—there are no required minimum distributions (RMDs),” note Bob Sullivan and Benjamin Curry in Forbes.
“Uncle Sam wants to make sure he eventually gets tax revenue from funds saved in other types of tax-advantaged retirement accounts,” they add. “So the IRS mandates that you begin withdrawing RMDs from most retirement accounts based on IRS life expectancy tables.” Generally, traditional IRA funds will begin to be taxed at age 72.
“RMDs increase your income later in life, potentially increasing your tax bill and possibly impacting other means-tested benefits, such as Medicare premiums,” explains Sullivan and Curry. “The option to leave your Roth IRA savings untouched grants it a big benefit over other retirement vehicles.”
4. Better terms for your heirs.
Would you like to ensure that your beneficiaries are taken care of, while also not posthumously smearing your name? Well, Roth IRAs can take care of both.
With traditional IRAs and other retirement accounts like 401(ks) beneficiaries are required to pay taxes on withdrawals. That’s not the case with Roth IRAs as these distributions are generally tax-free. Before attempting to use Roth IRAs in an estate plan, speak with an attorney or estate planning expert.
5. Tax flexibility in retirement.
As long as you follow the rules, you can withdraw your Roth IRA money tax-free since you’ve already paid taxes on your contributions. It may be possible to better manage your overall income tax liability in retirement if you combine your traditional IRA withdrawals with withdrawals from your 401(k)s and Roth IRAs.
For example, you could withdraw from a traditional IRA until your taxable income reaches the highest tax bracket. Then, you can withdraw additional funds from a Roth IRA as needed.
6. Protect yourself against future tax increases.
How much higher will tax rates be in the future? No one can predict the future. But the top federal income tax rate remains lower than its historical highs. As such, a Roth IRA may make sense if you believe it could rise again sometime down the road.
7. You can contribute at any age.
Regardless of your age, you can contribute to a Roth IRA as long as you receive a regular paycheck or 1099 for contract work. In fact, a Roth IRA does not have an age restriction. But, you must have an income below the limit to contribute — you must make less than $140,000 for single filers and $208,000 for married joint filers in 2021.
In short, this makes a Roth IRA an appealing retirement vehicle for both younger and older investors.
How to Turn $100 Into a $2.62 Million Roth IRA
There’s one more reason why you should purchase a Roth IRA. You can convert a hundred bucks into a cool $2.62 million.
No. Your eyes didn’t deceive you. Here’s how it’s possible courtesy of Jeff Rose, aka Wealth Hacker.
So let’s say you’re 19 years old and a hundred dollars to start with. From there, you contribute $3,000 annually, or $250 a month.
If you do that up until the age of 65, you’ll average a 10% return. Your total earnings will be $2,620,943. So yes, if you start with $100 and add $3,000 a year, your Roth IRA can grow to $2.62 million.
It becomes even more powerful when you take a look at how much money you put into it.
For example, if you contribute $138,000 of your own money during that timeframe, and your profit is almost $2.5 million dollars!
As Larry David would say, that’s pretty, pretty good.
“When I discovered this, this is what really solidified me investing for myself and investing into a Roth,” says Rose. And, that’s when be began cranking it up and putting money into a Roth IRA.
“But hold on, hold on. It gets better,” he adds.
Imagine you still start with $100. But instead of investing $3,000 annually, you invest $5,000 a year ($416/month) during the same timeframe and rate of return. Now we’re looking at a grand total of $4.3 million, or $4,362,892 to be exact.
And once again, the amount that you put in is $230,000. This would grow to be 4.3, almost double of what we saw previously, just by tacking on an additional $166 per month.
What if you aren’t 19?
Start regardless of your age. And, also don’t worry if the market’s only average is 8% instead of 10% or 12%. Why? Because a Roth IRA is still amazing.
What if you had 750K instead of 4.3 million or 2.62 million bucks? What if you put in $138,000 and it only doubled to $260,000? Are you really going to get bent out of shape over that?
The most important takeaway, though, is at least you saved. You also invested in yourself. And, no matter the amount, with a Roth IRA, not only will it grow substantially, you’ll end up with more than you began.
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