Roth IRA’s will provide tax free income in retirement, do not sleep on these accounts! Read on to learn everything that you need to know!
What are the rules for Roth IRA’s?
When in doubt, I always turn to the rule maker with questions like this. There are hundreds (if not thousands) of sources out there and you can never be too sure that everything you see if factual.
What if I don’t feel like reading IRS mumbo-jumbo?
That’s cool! I don’t blame you, I zoomed out on the main resource page for both Traditional and Roth IRA’s and it’s an absolutely insane amount of information.
I did it for you anyways, let’s break it down into terms that make more sense!
A few of the high points:
Roth IRA contributions are made with money that you have already paid taxes on
You can contribute up to $6,000 / year ($7,000 if you are 50+ years old)
Qualified withdrawals are tax free!
Distributions taken after the age of 59.5
There are other exceptions/exemptions that go beyond the scope of what I would like to cover here, consult a CPA if you want to take money out but are not 59.5 years old. Let’s do our best to avoid taking money out early!
I’ll throw in a very cool flow chart from the IRS below
You cannot contribute to a Roth IRA if your annual income is over $140K (single) $208K (combined married filing jointly) as of this writing in 2021
That all sounds pretty cool, how do I open a Roth IRA?
Glad you asked! Almost all major brokerages offer these accounts!
One thing I would consider, if you already have a standard taxable brokerage account with one broker, it will be a whole lot easier to open the Roth IRA with them so you only have to remember one password and log on to one site / app to check everything!
Great! Are there any other cool things to know about these accounts?
Sure are! With individual retirement accounts, unlike employer sponsored plans, your investment choices are super flexible! You have no obligation to make garbage target date funds with awful expense ratios! You can buy (most) individual stocks, you can look into low cost index funds / ETF’s, the choice is yours!
Heard of index funds but aren’t sure what all the hype is about?
What’s the best thing about Roth IRA’s?
Without a doubt, the tax free distributions. If, like so many (including me), you are not in that high income group that cannot take advantage of these accounts, you are going to love the tax free income in retirement. I cannot tell you how many times people that are 60+ years old have told me that their single greatest regret – at least from a retirement saving standpoint – is not starting a Roth IRA sooner!
Many forget to factor in taxes with traditional IRA’s, 401(k)’s, and other tax deferred retirement accounts. There is absolutely a place for these, don’t get me wrong, but you will have to pay income taxes on distributions for those account types when the day comes that you can tap into them.
Tax advantaged now or later?
Roth IRA’s are funded with after-tax money. Why am I a fan of that, personally? Your guess is as good as mine on what income taxes will look like 20, 30, 40+ years. from now. With this account type, I am 100% sure what the tax rate I will have to deal with is. Upon reaching 59.5 years old, I will not have to worry about the tax environment for withdrawals I take from this account.
Those pre-tax funded accounts? Sure, they benefit by growing pre-tax so there is more money that is growing. Even if income tax brackets stay exactly the same a few decades from now as they are right now (highly doubtful) you should hopefully have a higher income later in life than you do now! Thus, you would want to take care of taxes now!
Tell me about Backdoor Roth IRA’s
Ah, one of the most used buzzwords this year. A backdoor Roth is not a special type of account. I am not going to dive too far into these, I’m not very optimistic on the long term outlook of this financial ju-jitsu as it seems fairly likely to be outlawed before long.
Essentially, keeping things simple, all that this is is converting a Traditional IRA to a Roth IRA.
Why would someone do this? If you remember from above, you cannot contribute to a Roth IRA and reap the sweet, sweet tax free income in retirement if you make too much money. This gets around that.
If you want to learn more, here is an excellent article from Investopedia.
An important reminder
Please, please, please understand that Roth IRA’s are just accounts. They are not investments. You have to actually do something with the money you contribute to this account, don’t just let it sit in cash! This goes for all retirement accounts!
Didn’t feel like reading everything above?
I made a video! Check it out!
The second half of that details a table of possible account values given a certain return, these accounts can grow to some significant values if you max them out year after year!
Roth IRA’s are fantastic accounts. If there is any single thing I would suggest you do if you fall under the income limit, open one ASAP and work on maxing it out every year. Do this from a young age and this could grow into a million + dollar tax free income generating machine when you retire.
As always, thank you so much for taking the time to read this! Please do not hesitate to reach out and contact me with any thoughts, suggestions, questions or whatever!