If you’re just starting to save up for retirement, I know how confusing it can be. With are so many options – how do you set up the right plan for you, and stick with it?
A Roth IRA is a simple option for retirement savings that not everyone is aware of. These accounts are accessible for anyone, at all ages and stages of employment. The requirements are straightforward, and the benefits are awesome.
Want to learn more? Here’s a super easy explanation of what a Roth IRA is, and how you can use it to invest in your future.
The Overview: What is a Roth IRA?
IRA stands for Individual Retirement Account. Unlike a 401(k), which is a retirement plan sponsored by your employer, an IRA is opened and managed by you, as an individual.
Through your IRA, you can invest your money into various stocks, bonds, or mutual funds. Your contributions will earn compound returns over time, and you can access the money after you reach retirement age (59 ½).
A Roth IRA is a specific type of IRA that allows you to contribute your after-tax dollars. That means that your investments will grow tax-free over the years. When you reach retirement age, you’ll be able to withdraw exactly what’s in your account, without paying taxes on it.
These accounts are designed to be accessible and to maximize growth on smaller investments. They’re great for supplementing a 401(k), or to use as your main retirement savings account if you don’t have a 401(k).
Who can open a Roth IRA?
The main difference that sets Roth IRAs apart from 401(k)s is that you don’t need an employer to sponsor your account.
So, if you already have a 401(k), you can open your individual savings account on top of it to get the most out of your retirement savings. Or, if you aren’t traditionally employed, you can open a Roth IRA in place of a 401(k).
You will need to certify that you have income to open your account. That can be in the form of freelance earnings, tips, or wages – whatever funds support you. If you are married and not currently working, your spouse can open a Roth IRA on your behalf.
There is an income limit to Roth IRAs. If you make more than $124,000 annually, as a single-income tax payer, your annual contributions to your account will be limited. If you make more than $139,000, you won’t be eligible – this keeps IRAs accessible for the people who don’t have another resource for retirement savings.
How does it work?
Saving for retirement with a Roth IRA is fairly straightforward. Here’s how it works, in a few simple steps:
1. Getting started
If you’re eligible to open a Roth IRA account, getting started is pretty easy.
First, choose an investment broker to open your account with. If you already have an investment account, talk to a representative at your investment company about opening a Roth IRA with them. Fees, investment options, and trading costs will vary with each company – so be sure to shop around and find the best broker for you!
At the start, you’ll design your own portfolio by choosing which funds you want to invest in. Then you can set up a contribution schedule to automatically make payments into your account each month. Once your account is open, you’ll want to regularly monitor your investments, and occasionally buy or sell to keep your portfolio balanced.
You can also use a robo-investor to invest in your Roth IRA, which will take a lot of the work off your hands and keep track of your portfolio for you.
2. While you save
Once your Roth IRA is up and running, you don’t have to do much for the account to grow.
Your contributions are limited to $6,000 each year, and $7,000 each year after you turn 50. There is no minimum contribution. If you have automatic contributions set up, you won’t have to worry about transferring that money yourself.
It’s important to note that in the case of an emergency, you can withdraw your contributions (all the money you have invested) from your Roth IRA any time, without any taxes or penalty charges. However, if you want to withdraw your earnings (returns on investments) before age 59 ½, you will have to pay income tax on them, and you’ll be charged a 10% fee.
There are some exceptions to that rule, for emergencies and major payments, which I’ll get into later.
3. After retirement
The cool thing about a Roth IRA is that after you reach 59 ½, there are pretty much no rules to how you use your funds. That money is all yours – and it isn’t taxed.
Other retirement savings accounts have an RMD, or required minimum distribution – meaning you have to take out a certain amount of your savings before age 70 ½.
With a Roth IRA, there is no RMD. The money in your account is yours to use, tax-free, however and whenever you want to use it!
Advantages of a Roth IRA
Like any investment account, there are pros and cons to opening a Roth IRA. Here are some of the key advantages of Roth IRAs compared to other retirement savings options:
1. It’s an option for people who aren’t traditionally employed
For a lot of Millennials, opening a 401(k) simply isn’t an option. Tons of young people are choosing freelance and entrepreneurial careers over traditional employment – which means they can’t access a regular 401(k). A solo 401(k) is an option if you still prefer that type of account.
A Roth IRA is a great way to make sure you don’t lose track of your retirement savings, no matter what your employment situation looks like. As long as you have income, you can open an account and start contributing.
And, since parenthood is a job, too, Roth IRAs give you the option for your spouse to open an account in your name, so you can still save while you’re busy with the little ones.
2. Tax-free income in retirement
When you reach retirement age and start to withdraw your Roth IRA savings, you won’t have to pay income tax on them. That way, your money will go a lot further!
In addition, your investments aren’t taxed, so there’s a huge potential for growth for a smart investor.
3. You can use your earnings for important payments
There are a few exceptions to the penalty charges for withdrawing your Roth IRA earnings before retirement.
You won’t be charged if you withdraw up to $10,000 (or $20,000 for a married couple) for a first-time home payment. Likewise, you can withdraw earnings to pay college tuition for yourself, your spouse, or your child. You can also use your Roth IRA funds to pay for emergency medical expenses, if they exceed 7.5% of your annual income.
4. No age limits or RMDs
With other savings accounts, you will have to stop contributing and have withdrawn a certain amount of your savings by age 70 ½. With a Roth IRA, on the other hand, there is no age limit to opening or contributing to your account.
There is also no required minimum distribution. You can withdraw as much as you want, at any age over 59 ½, with no consequences, taxes, or fees.
Disadvantages of a Roth IRA
Roth IRAs are awesome for retirement savings, but they aren’t your only option. Here are a few areas where a Roth IRA might fall short compared to another type of retirement savings account:
1. There is no tax break upfront
Your Roth IRA funds are tax-free when you withdraw them for retirement – but you do have to pay taxes on the money you’re contributing to your account.
With a 401(k), on the other hand, you’re contributing your pre-tax dollars, which means the more you contribute in a year, the better tax break you’ll get.
2. You have to manage your account on your own
Opening, contributing to, and managing your Roth IRA is all up to you. You’ll have to regularly check your account and make sure your portfolio is balanced. That can be tough for someone who doesn’t have a lot of time on their hands.
Fortunately, thanks to modern technology, this isn’t as much of a disadvantage as it used to be. Tons of investment companies offer robo-investment and automated services to make it easier for you.
3. There are contribution limits
Your contributions to your Roth IRA are limited to $6,000 a year, and $7,000 a year after you turn 50. In contrast, a 401(k) has limits of up to $19,000 in one year.
So, if you really want to make the most of your retirement savings, a Roth IRA alone might not be enough – that’s why tons of financial experts recommend opening both a 401(k) and a Roth IRA, if possible.
It’s easy to start saving
Investing in your retirement can feel like a big task, especially if you aren’t traditionally employed. But with a Roth IRA, it’s actually a lot easier than you might think.
If you’re interested in opening a Roth IRA, get in touch with a representative of a trustworthy investment company. Once you open your account, you’re good to go! You can keep saving and growing your investments no matter what your employment situation looks like. Plus, you can withdraw your contributions tax-free if you ever need them for an emergency payment.
Investing in a Roth IRA is practically risk-free. It’s a great option for anyone, whether or not you already have a 401(k). Even if you quit, change jobs, or your company closes, your Roth IRA savings will stay with you.
The sooner you start saving for retirement, the better – so why not get started today?