In the world of retirement investing options, there’s one savings plan that stands out head and shoulders above the rest. It’s easy to set up, simple to maintain, and comes with tax advantages that enable you to build wealth and increase your retirement savings for the long haul.
That’s right—I’m talking about a Roth IRA. Whenever you hear the word Roth, I want your ears to perk up a little bit. That’s because Roth basically means tax-free growth! We’re going to talk more about that in a minute.
Maybe you’ve heard about these retirement savings accounts, but you haven’t had time to discover if they’re a good option for you. I’m going to answer the most common questions about Roth IRAs and show you how this investing tool can help your wealth skyrocket over time.
1. What is a Roth IRA and how does it work?
A Roth IRA (Individual Retirement Arrangement) is a retirement savings account that allows you to pay taxes on the money you put into it up front. The growth in your Roth IRA and any withdrawals you make after age 59 1/2 are tax-free, as long as you’ve had the account more than five years.
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Because you pay taxes on the front end with a Roth IRA, you don’t owe them in retirement.
If you want to contribute to a Roth IRA, you must open and maintain it outside of your employer-sponsored retirement savings plan.
2. What are the benefits of a Roth IRA?
The Roth IRA has some serious benefits.
Let’s start with the tax impact. When you make contributions post-tax, that means you’ve already paid taxes on the money you set aside for retirement. That helps your retirement savings go a lot further! Here’s why:
- The money you invest in your Roth IRA grows tax-free.
- You won’t owe taxes when you withdraw your money in retirement.
So, if your account grows by hundreds of thousands of dollars over time, you won’t owe taxes when you withdraw that money in retirement! That’s a huge perk, especially for folks who expect to be in a higher tax bracket when they retire. Talk about a win!
Here are a few more benefits of a Roth IRA:
- You’re not required to take distributions at a certain age, unlike the traditional IRA (which requires withdrawals beginning at age 72).
- You can keep contributing to your Roth IRA if you choose to work past retirement age, as long as your income still falls within the income limits.
- You can choose beneficiaries to inherit your account, and they will be able to withdraw funds tax-free as well.
3. How much money do you need to start a Roth IRA?
The great thing about Roth IRAs is that you don’t need to invest a ton of money to open an account. In fact, the IRS doesn’t require a minimum amount to open a Roth IRA. Most mutual fund companies require an account minimum to open one, but you can start a Roth IRA with as little as $50 in most cases.
That means there’s no need to put off investing, people! Once you’re out of debt with a fully funded emergency fund, you can dive right in. Working with an investment professional makes the process feel like a breeze.
4. Can you lose money in a Roth IRA?
The short answer is, yes. There’s always going to be an element of risk when you invest, but you can minimize your risk by spreading out your investments evenly across four different types of stock mutual funds: growth and income, growth, aggressive growth, and international. That way, you’ll balance and diversify your portfolio between higher-risk investments and more steady and predictable ones.
And listen, if the market has a bad day, don’t panic and take all your money out of your Roth IRA. That is the worst thing you can do, because all you’re doing is locking in your losses. Don’t do it!
Investing in the stock market is like riding a rollercoaster—the only people who get hurt are the ones who jump off. The investors who keep their cool and give their money time to grow are the ones who get to the end of the ride safe and sound. When in doubt, reach out to an investment pro for guidance!
5. Roth IRA vs. Traditional IRA: How do they compare?
That’s a great question. The main difference between a Roth IRA and a traditional IRA is how they’re taxed. Take a look at a side-by-side comparison:
In most cases, contributions are tax deductible.
Contributions are not tax deductible.
There are no annual income limits on contributions.
In 2020, you can contribute up to the limit if your gross income is less than $124,000 for single filers and $196,000 for married couples filing jointly.
You must make annual withdrawals from your IRA after you turn 72.
No withdrawals are required if you are the original owner.
You must pay taxes on withdrawals in retirement.
You are not taxed on withdrawals in retirement.
6. Am I eligible for a Roth IRA?
Do you earn income? Then, yes. You’re eligible. However, you can’t contribute more than you make. So, if your 19-year-old son or daughter earned an income of $3,000 waiting tables over the summer, they can only contribute up to $3,000 to a Roth IRA. It’s also okay for you to contribute the $3,000 on their behalf.1
Another perk: There are no age restrictions with Roth IRAs. Whether you’re 17 years old or you just turned 92, you can contribute to your account as long as you’re earning an income.
7. What are the 2020 contribution limits?
You knew there had to be a catch! Unfortunately, Uncle Sam says you can’t just put as much money as you want into an IRA. For 2020, the total amount you can contribute to either a Roth IRA or a traditional IRA is $6,000—or $7,000 if you’re age 50 or older.2
8. Are there Roth IRA income limits?
A Roth IRA offers some great tax benefits, but it’s not available for people with high incomes. Uh-oh.
Income Restrictions If Single
According to the Internal Revenue Service, single tax filers must have a modified adjusted gross income (MAGI) of less than $124,000 to contribute the maximum amount of $6,000 ($7,000 if age 50 or older) to a Roth IRA.3
What if you make more than $124,000? If your MAGI is between $124,000 and $139,000, you can still contribute, but it must be a reduced amount. Once you’re making more than $139,000 as a single filer, you aren’t eligible to contribute to a Roth IRA.4
Income Restrictions If Married Filing Jointly
Married couples filing jointly must have a modified AGI of less than $196,000 to be able to contribute up to the limit for a Roth IRA. After that, you may qualify to make reduced contributions if your AGI is between $196,000 and $206,000.
If you have an AGI of $206,000 or higher, you’re not eligible to make Roth IRA contributions.5
If your filing status is...
And your modified AGI is...
Then you can contribute...
|Married filing jointly or qualifying widow(er)||Less than $196,000||Up to the limit|
|Married filing jointly or qualifying widow(er)||Between $196,000 and $206,000||A reduced amount|
|Married filing jointly or qualifying widow(er)||Greater than $206,000||Zero|
|Married filing separately and you lived with your spouse at any time during the year||Less than $10,000||A reduced amount|
|Married filing separately and you lived with your spouse at any time during the year||Greater than $10,000||Zero|
|Single, head of household, or married filing separately and you did not live with your spouse at any time during the year||Less than $124,000||Up to the limit|
|Single, head of household, or married filing separately and you did not live with your spouse at any time during the year||Between $124,000 and $139,000||A reduced amount|
|Single, head of household, or married filing separately and you did not live with your spouse at any time during the year||Greater than $139,000||Zero|
If you’re self-employed, here’s another option: Establish a Simplified Employee Pension (SEP) or a Solo 401(k) plan. Or if you run a small company with employees, consider a simple IRA that will allow you and your team members to save for retirement.If your income exceeds the eligibility limits, good for you—but bad for your ability to open a Roth IRA. You won’t be able to stash your cash in a Roth IRA, but a traditional IRA might be an option. Tax benefits for traditional IRAs have different eligibility requirements, so check with your investing pro to see if it’s a good choice for you.
9. Can I set up a Roth IRA for my spouse who doesn’t work?
Yes. If you file a joint income tax return and have a taxable income, you can both contribute to your own separate Roth IRAs. But the IRS income-eligibility limits still apply.
Let’s say 40-year-old John makes $150,000 and his wife, Kate, stays home with their kids. John can put up to $6,000 in his IRA while Kate can open a spousal IRA in her name and contribute the maximum amount of $6,000 as well.
10. Is a Roth IRA the same thing as a Roth 401(k)?
No. But both accounts are taxed the same way. Adding the word Roth to the name of either savings plan means the money you contribute will be taxed up front, will grow tax-free, and can be withdrawn tax-free after age 59 1/2.
Roth 401(k) plans are sponsored by employers. If you receive an employer match on your Roth 401(k), the match is not tax-favored. That means the growth from your employer’s match will be taxed when you withdraw your funds in retirement.
If your job offers you a Roth 401(k) with a match, take it! You can contribute to both a Roth IRA and a Roth 401(k) at the same time.
11. How do I set up a Roth IRA?
The best way to open a Roth IRA is with the help of an investing professional who will meet with you face-to-face. Before you meet with your investing pro, you’ll need to gather some information and fill out the application. Here’s what you should have on hand in order to open your account:
- Your driver’s license or other form of photo identification
- Your Social Security number
- Your bank’s routing number and your checking or savings account number
- Your employer’s name and address
As part of the process of opening a Roth IRA, you’ll also choose a beneficiary (or beneficiaries) who could inherit your account. You’ll need their name, Social Security number and date of birth.
Next, you can make your initial deposit and/or set up automatic contributions. You’ll be able to open your Roth IRA with a lump sum up to the annual limit. Or you may choose to deduct a specific amount from your bank account each month. You can actually do both as long as you don’t exceed the contribution limit for that year.
12. What should my Roth IRA be invested in?
You can invest in almost anything through your Roth IRA, but we recommend mutual funds because they have the potential to help you build wealth over time—especially with a Roth IRA’s tax benefits.
Many mutual fund companies will allow you to start a Roth IRA with as little as $50, so there’s no need to put off opening your account until you have enough money to start investing.
13. How do I maintain my Roth IRA?
Once you choose the mutual funds for your Roth IRA, it’s important to stick with them for the long haul. Don’t panic when the market ebbs and flows. The value of your Roth IRA will rise and fall with the stock market, but over its lifetime, you should see a steady growth trend. Just continue making regular contributions and stick with it despite possible market changes.
Over 30 years, if you invest the annual max of $6,000 into a Roth IRA, it could grow to $1.4 million. The best part is, your contributions would only total $180,000, and the rest—$1.2 million—would be growth.
Those numbers can change depending on how much you invest, how long you have until retirement, and what you expect your annual return to be. You can use our investing calculator to customize those details for your own financial situation.
I’m ready to start! Now what?
Opening a Roth IRA is as easy as opening a checking account. The best way to get started is to contact an investing professional who can guide you through the set-up process.
If you don’t have a financial professional, reach out to a SmartVestor Pro in your area who is committed to educating and empowering you to make the best decisions possible for your retirement future.