Roth IRA: A Love Story

Investing is hard.  This is especially true for Millennials who are more concerned with paying the bills and starting a family than saving for retirement that’s still 20-40 years away. It can be confusing to try and determine which types of investment vehicles you need, how many, and how much money you should be contributing to each.

Believe it or not, there are some diamonds in the rough that offer up a simple, straight-forward means of saving money. The Roth IRA is one of those beautiful anomalies in the personal finance world. The Roth IRA is an investment vehicle that brings a unique element to your overall financial picture. It’s also one of the only options to offer tax-free growth and tax-free withdrawals in retirement.

If you aren’t aware of or haven’t considered opening a Roth IRA before, read on for irrefutable details (and a graph that will knock your socks off) that show why you need to consider opening one today.

What is a Roth IRA?

A Roth Individual Retirement Account (IRA) is an investment account that allows you to set aside after-tax money to grow tax-free with no tax on withdrawals after age 59 ½ as long as you’ve had the account open for five years. The “Roth” element of this simply means that you fund the account with after-tax dollars. By contributing money that has already been taxed, you receive the benefits of allowing your money to work for you without concern for taxes on the back end. Because of this, I believe it’s something all investors should have as part of their retirement portfolio.

Why the Roth IRA is my favorite investment

Yes, I have a favorite investment vehicle.  Doesn’t everyone?

I opened a Roth IRA at 25 thanks to the urging of a prior financial advisor and my dad.  Looking back and knowing what I know now, I couldn’t be more thankful to have started at that age. So many people are unnecessarily behind on retirement savings due to not starting until later in life. It doesn’t need to be this way. Exposing younger people to the benefits of beginning retirement investing early is one way we can make sure our generation and those who come after us can lead a more financially secure life.

Who is eligible to contribute to a Roth IRA?

Anyone with taxable income is eligible to contribute to a Roth IRA. But there are limitations for eligibility once you hit a certain income level.  In 2020, a couple who files taxes jointly and makes less than $196,000 is eligible for the full contribution amount.  For singles, anyone making below $124,000 is eligible.

What is the maximum contribution limit for 2020?

For 2020, the maximum Roth IRA contribution is $6000.  Thanks to COVID-19 (said no one ever, but maybe this is one of the few bright spots in all this?) Americans now have until July 15th to make contributions to their 2019 Roth IRAs.  The contribution deadline follows the tax deadline, which is the reason for the change.  Persons over age 50 are eligible to contribute $1000 more per year as a catch-up contribution.

The Roth IRA is a use it or lose it kind of thing in terms of contributions.  If you miss making your Roth IRA contributions for a calendar year by tax day (unless it’s this year and the deadline is extended), you can’t go back in time and make them up. That’s another reason why it’s essential to start now.

What are the benefits?

There are oodles of benefits to a Roth IRA including, but not limited to:

  • Tax-free growth.
  • Tax-free withdrawals after age 59 ½ if your account has been open more than five years.
  • Access to withdrawal contributions (not including growth) at any time for any reason. **Avoid doing this at all costs as you’ll miss out on future growth from that money. It’s best to have an emergency fund to use instead of this account. But it’s a good thing to know and one of the big reasons why these accounts are so popular.
  • Use funds for a first home tax-free as long as it meets qualified distribution rules.

I already have a 401K, or similar, through work, do I need both?

To me, that’s the equivalent of saying, “But I already walk the dog, do I need to do another exercise too?”  While some movement through walking is great, it would be a better thing for your body if you picked up some weights or did some stretching as well.  The Roth IRA is taking a good thing, like saving for retirement, and making it better, by offering tax breaks and less stringent requirements on borrowing should the need arise.

With lower limits than other retirement investment vehicles, $6,000 in 2020 for a Roth IRA vs. $19,500 for a 401K, it will take a lot longer to recognize gains.  The most important thing to remember is that this money is after-tax.  So by the time you’re investing it, your tax burden is done. Once you decide to use this account in retirement, you’ll be able to bask in the glory of having all of your money. This is as opposed to paying taxes on how much you take out of a traditional IRA, 401K, or similar taxable account.

I love this article from Investopedia that goes into painstaking detail the differences between the Roth IRA and virtually every other retirement account known to man. Check this out for any questions related to the differences in specific accounts.

Now the fun part

You need to try out this Roth IRA calculator from NerdWallet to see the benefit of opening a Roth IRA today.  I love that this calculator also highlights the differences between utilizing the Roth vs. a standard taxable account.  Below is the output for my calculation.  This graph assumes a retirement age of 65, current age 30, and $23,000 already in my account from prior year Roth IRA contributions.

If that image doesn’t make you want to open a Roth IRA today, I’m not sure what will. This curve looks even better if you’re a bit younger than me or already have a jump on savings. For one of our younger millennial counterparts, say, someone who is turning 25 this year and starts from scratch, they’re looking at a potential $973,000 at age 65.

If investing and saving for retirement seems too hard, remember:

  • Time is on your side.  If you’re part of the millennial generation, who will turn 24 to 39 in 2020, and planning to retire at the traditional retirement age of 65, you’ll have a minimum of 26 years to save towards retirement.  Compound interest is a heck of a thing. And 26 years is plenty of time for your money to grow and do work for you. (To the tune of $365,000 at age 65 for a 39-year-old who starts maxing out Roth IRA contributions this year.)
  • Your future self will thank you.  Take a second to consider who you might be 26 to 41 years from now.  For some, that might be a scary thing.  Often our future selves seem far away and unrealistic. The reality is, you’ll be there one day so you might as well support future you the best you can.
  • Planning now means potential early retirement later.  By taking the time to set aside money now and letting that money work for you, you may potentially be able to knock years off your working life.  As shown above, investing $6,000 per year starting today could turn into $973,000 by the year 2059 when the youngest millennials reach retirement age. In conjunction with other retirement accounts, this could seriously set someone up for an early exit from traditional employment.

Clearly, from everything I’ve outlined above, I am a huge fan of the Roth IRA.  Please keep in mind that this is only one element of your broader financial portfolio, though. It’s critical to consult with a Financial Advisor before making any financial decisions. An Advisor can help you create a complete picture of all of the investment vehicles you’ll use to cruise into a stable retirement.

Do you have a favorite investment vehicle?  Please let there be someone as nerdy as me out there who will comment that they do! 

Disclaimer: The above is my own opinion and is for informational purposes only. Views expressed above are not intended to be investment advice. While I might have some great ideas, seek a duly licensed professional for investment advice.

References:

https://money.cnn.com/retirement/guide/IRA_Roth.moneymag/index4.htm

https://investor.vanguard.com/ira/roth-ira

https://www.investopedia.com/articles/personal-finance/040714/how-use-your-roth-ira-emergency-fund.asp

https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2020

1 thought on “Roth IRA: A Love Story”

  1. Also a HUGE fan of the ROTH. The most fun is when it automatically comes out of your pay check and then you check it later and you are like oh my gosh I am suddenly rich!!

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