If you want to be a millionaire it doesn’t take as much as you think. In fact, it may only take you $6,000 (per year) or less if you take invest in accounts like a Roth IRA.
A Roth IRA is a retirement account you invest in after-tax and grows tax-free. Unlike traditional IRA’s that are funded with pre-tax income and you pay taxes when you retire. With a Roth IRA, there are several advantages from tax breaks to easy early withdrawals.
Roth IRAs offer tax-free growth
With a Roth IRA, you pay taxes upfront and your investments grow tax free. This is most beneficial when you expect your taxes to increase as you get older.
Since a Roth IRA is funded entirely using pre-tax dollars, you don’t need to worry about your savings being taxed after they have been deposited. When you withdraw your funds from a Roth-IRA account you receive the entire amount without incurring any taxes since it will have been funded with post-tax income.
In contrast to this, all traditional IRA account holders are required to pay taxes upon withdrawing funds from their IRA accounts post-retirement.
Here’s an example:
Let’s say you are 25 years old and you contribute & invest your Roth IRA for 40 years. The beauty of the Roth IRA is that you just get taxed on the money that you put in.
You contribute $6,000 annually to a Roth IRA for 40 years, so over your lifetime, you contribute $240,000. Thanks to compound interest, your investments can grow to $1.6 million growing at an 8% interest rate. With a Roth IRA, you only pay taxes on the contributions so only the $240,000 gets taxed and grows tax free. This can save you over tens of thousands over your lifetime.
Test it out with your numbers here
Early and easy access to retirement funds
Roth IRAs are extremely flexible and allow you withdraw funds before the age of retirement. If you withdraw any money before reaching the age of fifty-nine and a half, you will incur only a 10% withdrawal penalty.
In contrast, traditional IRAs have much higher penalties for early withdrawals and permit fewer early withdrawals for emergency expenses. This makes Roth IRAs ideal for anyone who wants to safeguard their prospects by as much as possible and intends to possibly make early withdrawals.
Penalty-free withdrawals are also permitted for emergency expenses related to health and medical expenses.
Roth IRAs are flexible for qualifying events
If you have one of the following qualifying events, you can withdraw from your Roth IRA penalty free. It is recommended to keep invested for as long as you can, but you know life happens.
Here are some of the qualifying events that will allow you to withdraw funds from your Roth IRA penalty free:
- Purchasing your first home – You can use up to $10,000 towards the purchase of your first time
- Higher Education – You can use your Roth IRA towards qualified education expenses
- Health Expenses – You can use your Roth IRA towards health insurance expenses if you are unemployed or unreimbursed medical expenses
Variety of Investment Options
Unlike your 401(k) or 403(b), you are not limited by your employers pre-selected investment options. If your employer only offers higher fee investments, your Roth IRA is a great opportunity to take advantage of lower cost investments.
A Roth IRA can be used to make investments in a number of different mediums including mutual funds, bonds, stocks, and money market funds. This great diversity of investment options has the benefit of allowing individual users a greater degree of stability on the return of their investments. This is one of the biggest practical benefits of investing in a Roth IRA account.
Within your Roth IRA you have the option to invest in almost anything.
Here are some options:
- Individual Stocks – Buying an individual stock or share means buying a piece of that company. This isn’t very diversified since you are only buying a piece of a single company.
- ETFs – ETF stands for “exchange traded fund” and is basically a basket of stocks (or other securities like bonds) that track a certain industry, sector or entire index.
- Mutual Funds – A mutual fund works just like an ETF but unlike ETFs you can invest by a cost basis instead of a per share basis
- Target Date Funds – A target date fund is a type of mutual fund that is managed for you and gets more conservative as you get older.
I'm in! What are the rules?
Contribution Limits: $6,000 (<50); $7,000 (50+)
For Single Individuals:
If you have a Taxable Income of up to $125,000, you can contribute up to $6,000
If your Taxable income is $125,001-$140,000, you can make a partial contribution
If your Taxable Income is over $140,000, you are no longer eligible
For Married Partners (filing jointly):
If you have a Taxable Income of up to $198,000, you can contribute up to $6,000
If your Taxable income is $198,001-$208,000, you can make a partial contribution
If your Taxable Income is over $208,000, you are no longer eligible
When can I withdraw?
Your contributions can be withdrawn at any time tax and penalty free, but your earnings may be subject to a penalty
Are there any penalties to withdraw early?
If you withdraw early, it will cost you to pay income taxes and an additional 10% penalty fee.
The Takeaway
Roth IRAs are a great tool to build wealth if you are eligible. They allow you to let your investments grow tax free in a relatively flexible account. Roth IRAs do not limit by your investment options, unlike your 401(k).
