A lot of you may or may not be fairly familiar with a Roth IRA. It isn’t very common knowledge, not enough people know what they should or could be doing for their retirement. Not enough people know that in order to have a safe retirement the best thing to do is to start ASAP, regardless of age.
What is a Roth IRA? What is a Roth IRA for? Should you be looking into opening one? As you read forward, you will be learning the basic details you must know when looking into opening up a Roth IRA. Things you MUST know before opening an account.
Once you have a read-through of the following points, you will have sufficient knowledge of the basics of a Roth IRA. Enough knowledge to go ahead and open an account for yourself.
What is a Roth IRA?
First off, what does IRA stand for? IRA stands for Independent Retirement Account. It is referred to as a Roth IRA because this particular account was named after its sponsor, William Roth, a former Delaware Senator.
A Roth IRA is different from a Traditional IRA which is discussed in a separate article.
Roth IRAs are accounts that are funded with after-tax dollars. The gains within the account are completely tax-free upon withdrawal at retirement age. This means that regardless of the profits you made within the account when you withdraw your money at retirement, you are not taxed on those profits.
Think of a Roth IRA as a shield or a house. When you have a house, you are free to decorate it and set up furniture within the house as you wish. Equally, within the Roth IRA, you are free to invest your money in any way you wish. Whether it is individual stocks, index funds, bonds, CDs, real estate, and more. The Roth IRA then serves as a shield to protect your gains from taxes, these gains are made from your invested money.
Roth IRA accounts are a good option for people who know that they will be in a higher tax bracket during retirement. If you’re young, making the beginner-level income, you better get to opening a Roth IRA account ASAP. This goes to almost anyone else as well, but younger people are the ones who are not paying enough attention to their future retirement plans.
So I’ll say it again, open your Roth IRA ASAP!
Who Qualifies to Contribute to a Roth IRA
Any single person making $139k per year or less (for the year 2020) is able to contribute. Any couple filing their taxes jointly making $206k per year or less together (for the year 2020) qualify to contribute to a Roth IRA.
Yes, basically if you’re too rich, you can’t contribute to a Roth IRA.
But there are certainly ways to get around this barrier. For example, if you own your own business and make more than the limit on a yearly basis, you can simply list yourself as an employee of your company and file what you pay yourself as income. Ideally, that amount should be less than $139k.
The rest of the income will simply be filed as going toward the business or going to you in the form of a distribution. You can do this by running your business through an S-Corp, but this is a different conversation.
Keep in mind that these limitations on a Roth IRA are per the year of 2020 and are subject to change. They have changed throughout time and will continue to change in the future.
The limit to how much you can make to contribute to a Roth IRA is not the only thing that is subject to change. The amount that you can contribute to your Roth IRA account is also subject to change.
Which leads me to my next point…
How Much can be Contributed
Roth IRAs set a limit of total contributions of $6k per year for single people ($7k per year if you’re over the age of 50) for the year 2020. For people who are married, they can contribute a maximum of $6k per year for each spouse to a total of $12k per year ($7k per year for each spouse to a total of $14k per year once both spouses are over the age of 50) for the year 2020.
If you’re making less than the limit of contribution toward a Roth IRA (ie: less than $6,000 per year), you may only contribute less or equal to your yearly income. Keep in mind that this income must be after-tax income.
You cannot contribute pretax income to a Roth IRA.
The window in which you can make contributions toward your Roth IRA for a certain year is the same as the tax year. April 15th of the prior year to April 15th of the next year. This window was extended in the year 2020 due to the COVID-19 pandemic.
You are also only able to withdraw profits from your account without getting taxed on them after the age of 59.5. If you withdraw any of the profits that your funds have made prior to that age, you will be penalized.
You are able to withdraw funds from your account, penalty-free, before the age of 59.5 only if they are funds that you have contributed.
Here’s an example:
If I contributed $5k to my Roth IRA and have made a profit of $4k, the total in my account is now $9k. If I am under the age of 59.5, I can withdraw $5k from the account completely penalty-free, while the $4k profit is subject to penalty.
I would not recommend doing this, though. You should avoid withdrawing any funds from your Roth IRA account until you are ready to retire. This is why you should keep an Emergency Fund at hand, in case of unexpected expenses. Do not use your Roth IRA funds. You will be missing out on amazing compound interest by doing this.
Also, if you’re invested within volatile funds, don’t withdraw funds just because the economy or markets are going downhill (unless you’re near the age of retirement). Just keep investing consistently and ignore the media. Something you have on your side is time. Time is your ally, and it will get you out of those down dips.
When you invest in down dips, you are also buying those investments at a lower price. This price will go up later in the future and you will be able to make very nice profits from the consistent investments you’ve been making.
Beware of Fees… What type of investor are you?
When you are investing in a Roth IRA you must keep in mind that there are different fees for different accounts. If you are an active investor/trader, you should be looking for a provider with lower trading costs.
A passive investor who lets their money sit and grow in a certain investment for a longer period of time should look for an account with no inactivity fees.
Also, make sure to find out what the advisory, service, or maintenance fees are. Each provider has varying charges on this aspect as well. It is important to do your research on what these fees might be before you open your account. I personally look for anything that charges less than 1% or a fixed dollar amount.
This is why I like Wealthfront and Vanguard. Their fees are minimal. I can keep my money well invested and diversified within these accounts.
Opening a Roth IRA
Keep in mind that there are several types of Roth IRAs. You have many options ranging from Savings and Loan Associations, Brokerage Companies, Federally Unsecured Unions, and Banks. I personally like to keep my Roth IRA in two separate brokerage accounts: Vanguard and Wealthfront.
I have accounts in both of these brokerage companies but the total contributions for a given year must still be a total of $6k for both accounts, not $6k each. When opening an account you want to know what you are looking for.
Are you planning to be a passive or active investor? Do you want to do the work? Would you rather have your investments automated?
I personally like things to be automatic but I keep a little bit more liberty in one of my accounts than the other. The investments I have in my Wealthfront account are completely automated and handled by a Robo-Advisor. It automatically rebalances my investments according to my risk tolerance.
My Vanguard account is more controlled by me. Within it, I get to choose what type of investments I want. As well as choosing how and when to buy each investment. I can rebalance if I wish to, or I can keep it the same. Both are very useful but due to the benefits of automation, I keep more funds in my Wealthfront account than my Vanguard account.
In my Vanguard account, I currently only buy index funds. My Wealthfront account does the same thing but I don’t get to choose what they are. However, after taking their tolerance test they gave me a designated plan that works with my tolerance level, and I’m very happy with how Wealthfront allocated my money.
Overall, opening an account is very simple and can be done online. My top recommendations are Wealthfront and Vanguard; others might differ. Regardless, you won’t be disappointed using these and you will begin to see your money grow within them. You now have the knowledge necessary to know what to do and expect from your Roth IRA.
Time to open your account! Feel more than free to leave any comments below, I’ll be answering each of them!