What Is a Roth IRA?
A Roth IRA is another type of retirement account that you fund with post-tax money. Roth IRA’s are similar to a 401K, but they have one big difference. A 401K is taxed when you withdraw your money (when you retire), and a Roth IRA is taxed the second you put money into the account. If you’re following along, this means that with a Roth IRA, you are not taxed when you withdraw your money. Also, since every cent in your Roth IRA is your money (no tax inflation from the government AKA 401K), you can pull it out at anytime. Tax free and penalty free.
If you’re considering a Roth IRA, it is important to take into account which tax bracket you fall into. These accounts make most sense if you plan on being in a higher tax bracket when you retire. This makes Roth IRA’s ideal for younger, lower income workers since they most likely aren’t missing the upfront tax deduction. These type of workers are more likely to benefit from decades of tax-less compounded growth.
Below is a quick example. Assume you start fresh with $0 and put in the maximum $6,000 a year for 40 years at an 8% return.
Am I Eligible?
The short answer is maybe. Roth IRA’s have eligibility requirements, so if you’re making too much money, you aren’t allowed to contribute. However, most Americans don’t have this issue and so if you’re like most, there should be no problem.
You’re going to want to be contributing the maximum if possible. For most, this will be $6,000. However, if you’re age 50 or older by the end of the year, you will be able to contribute an extra $1,000 a year bringing the maximum to $7,000. Take a peak at the chart below to see what you can contribute based on your income and filing status.
Two quick mentions:
- MAGI stands for modified adjusted gross income.
- Phasing out means that you are at or about to be at the MAGI limit and will be required to contribute less. Read more about phasing out here.
2019 Roth IRA Income & Contribution Limits
Should I make one?
Absolutely. Roth IRA’s are one of the best vehicles to wealth and provide a lot more flexibility than other retirement options. Keep in mind though, a Roth IRA should not (although it could) be a substitute for other wealth building vehicles like a 401K. If your employer is willing to match a percent of your 401K contributions, you definitely want to be taking advantage of that in addition to contributing to a Roth IRA. That is a topic for another post, but the gist is that you want to have multiple vehicles building your wealth. Not just one.
With a Roth IRA, being able to collect your money tax and penalty free is one of the greatest benefits. However, there are a couple more I should mention:
- No mandatory withdrawals: Roth IRA holders are not forced to withdraw their money beginning at age 70 1/2 like traditional IRA’s. This allows the account balance to continue to grow for things like estate planning.
- You can save during retirement: You can still make contributions to your Roth IRA even if you work past retirement age. Just stay within the income limits in the chart above!