If you are new to the Roth IRA, this is the place to be. I am going to show you the three reasons to open a Roth IRA, potential negatives, and the best ways to invest in a Roth. I will also include my Roth IRA plan, how I track my progress, and a 52 week savings challenge!
Every year, my wife and I are looking for new investment opportunities. We spend a large amount of time reading, thinking, and testing different markets. But before we do any of this, we max out our Roth IRA’s first. This is our safety net. If every other investment we have results in failure, we will still retire millionaires. Here’s what happens when you invest $5,500 into a Roth IRA at an 8% interest rate every year. Keep in mind this is for one person, so if you’re married you can DOUBLE this.
This is why I am a Roth IRA fanatic. If you are not familiar with a Roth, I will give you a rundown of how it works. I have found it is an amazing way to plan for your retirement.
Here are three reasons why:
1. Manageable to Max Out
If you are under the age of 49, you can contribute $5,500 to your Roth IRA per year. Break this down monthly and it comes out to $458.33. If that sounds like more than you can save, I have put together a weekly ROTH IRA savings challenge below. This should be manageable for anyone. Even with an entry level salary.
2. Your Contributions Can Be Withdrawn Without Penalty
A Roth IRA is funded with after tax income. The amount you contribute to a Roth IRA can be withdrawn at any time, without penalty (Although I would never advise taking money out). You just can’t pull out any of the money you earn in your account (i.e. interest or dividends).
Say you are in your 40’s, and you have contributed $40,000 to your Roth IRA. Your roof caves in on your house and you have no extra money to cover it (this would never happen to a DXD reader now would it?). You can take out $10,000 for the repair without fees or penalty. This is freedom you don’t have in a 401K.
3. Grows Tax Free
Since you contribute with after tax money, a Roth IRA can grow tax free. So every dollar your money earns, can be withdrawn in retirement without being taxed. This is a huge benefit for me. As you can see from the chart above, you only need to contribute $5,500 per year, but the account will earn millions. That is a million tax free dollars!
This is a benefit you don’t get with your 401K. Since the 401K’s contribution is pre-tax money, you must pay taxes when you take money out.
Let’s make it simple:
Roth IRA: Pay taxes going in. No taxes pulling out. 401K: No taxes going in. Pay Taxes going out.
Got it home slice? Cool.
Potential Downsides to a Roth IRA:
1. The Withdrawal Rule
To withdraw the money earned beyond your contribution, you must be 59 and a half. So, if you plan on retiring early, you may have to get a little creative if you plan on using this money right away.
2. Income Limits
There are income limits to the Roth IRA. If you and your spouse make $194,000 or more, you can not contribute to a Roth IRA. As an individual, if you make over $132,000, you also can not contribute.
But never fear high earners, there is a solution to this wonderful problem. That solution is called the backdoor Roth IRA.
The IRS will allow high earners do one conversion per year. Meaning, they can convert from their Traditional IRA, to their Roth IRA. You will be responsible for paying taxes, since the traditional Roth IRA is funded with your pre-tax dollars.
Some fear that the government will crack down and take this option away. Only time can tell. When it was introduced in 2010, there was an 800% increase in IRA conversions.
What type of investment are good for a Roth IRA?
1. Index Funds
Index funds are what I put in my Roth IRA. They are a great way to save for retirement without a worry in the world. I invest in Vanguard, specifically VTSAX, in my ROTH IRA. The chart above shows what will happen when you invest in this fund.
2. Dividend Stocks
The purpose of a dividend portfolio is to earn cash flow in the form of a dividend to supplement your lifestyle. A Roth is a great place to put your dividend stocks. That is because every dollar earned is tax free. So you have a tremendous advantage in retirement when you are taking those dividends to pay your expenses.
3. Value Investing
Value investing is great in a Roth IRA, because again, your money goes tax free. Since value investors look for undervalued stocks, this is a huge benefit.
Where I Track My Roth IRA
The best place I have found to track my Roth IRA is Personal Capital. It is so easy to set up and they have a beautiful layout of charts and graphs that show you exactly how well your Roth IRA is performing. Additionally, you can link up your bank accounts and other investment accounts as well, so all you have to do is check one app. No more thumbing through 6 websites to get your financial picture, it is all in one spot!
The Roth IRA Savings Challenge
Use this challenge to save for your Roth IRA. The savings starts small and snowballs from there. You’ll be amazed at how fast you can max out your Roth.
If you plan to use a Roth IRA for your future the time is now. Every year that you don’t max it out, is another year gone. You can’t backtrack all the years you didn’t contribute. It’s now or never.
Do You have A Roth IRA?