What is a Roth IRA?
A Roth IRA is a type of retirement account. It’s a very popular option for those looking to build real wealth because you can purchase stocks, bonds, notes, precious metals, and even real estate inside it, and anything your investments earn are never taxed. You won’t owe taxes, and neither will your spouse or children when they inherit it from you.
They’re kind of a big deal.
If you’re serious about building an empire of passive income, you need a Roth IRA. How To Open Your Roth IRA (And Why You Need One), I explained how your investments grow tax free within the account. This alone is reason enough to get one. You may not realize though that a Roth IRA is versatile enough not only to be used for retirement, but can be used to build for all kinds of big financial milestones in your life. Your Roth IRA should be the primary place you put the money you pay yourself. After you have an emergency fund established and get the match from your employer on your 401k (if your employer offers that), your primary goal should be maxing out your Roth IRA.
Tax-deferred accounts (traditional IRAs, traditional 401ks) mean that you get a tax break on your contributions now. The US government is not stupid, however. There’s a reason they offer you this tax break.
They know that if you’re putting money away diligently and investing it wisely, it’s going to grow, and it’s going to grow exponentially. They’re giving you this “break” on taxes now, because they know that down the road when you withdraw, their cut of your money that you pay on taxes will be much larger than if they take the taxes now. Basically, they’re giving you immediate gratification to encourage you to invest, so they can have you pay taxes on a much larger chunk of money down the road.
Not only are you going to be taxed on a larger percentage if you use a traditional account like a 401k or traditional IRA, but you aren’t even given special tax treatment on your investments the way you normally are with taxable accounts. They tax this money as regular income when you get to retirement.
Smells like a rip off from Uncle Sam.
Here are some more quick reasons to make your Roth IRA the primary home for all your extra coins:
When you invest your money instead of save or spend it, that money now works for you. The secret is compounding, and it’s one that too many people don’t understand can make them very wealthy.
Even though you don’t get to deduct your Roth IRA contributions on your taxes, if you fall below certain income limits, you may be eligible for a tax credit called the Saver’s credit.
Your fees in your Roth IRA can be really low and can make the difference between having $50,000 or millions when you retire. Your 401k will destroy your nest egg, which is why you should contribute enough to get your match and not a penny more. The rest should go in your Roth IRA!
You and your spouse can and should each have a Roth IRA, especially if you can for sure max one out. This gives you $11,000 you can contribute in total to grow tax-free.
If you own a business, your children should also have Roth IRAs, if they are old enough to complete simple tasks like empty your office trash can, vacuum, or put stamps on envelopes. There’s more to that, so don’t run off to hire them just yet, but it can be a huge benefit to your family net worth when executed properly.
Roth IRAs are amazingly flexible accounts. You can even own real estate in your Roth IRA with the right custodian (which I have and do). All that rent you get is then tax free. (Again, there’s more to that, but Roth IRAs are pretty amazing.)
You can withdraw your CONTRIBUTIONS from your Roth IRA at any time for any reason if you’ve been contributing to a Roth IRA for 5 years or more. (You can’t remove your earnings from your Roth IRA until you’re 59 1/2 unless you want to pay a penalty).
You can get around the 5 year rule, if:
- You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
- You use the withdrawal to pay for college for yourself, your spouse, or your kids.
- You become disabled.
- You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
While retirement should always come before saving for college, putting college funds into your Roth IRA has an added benefit of having zero impact on financial aid, if you plan to apply for your son or daughter.
You could, if you contribute and invest aggressively and early enough in your Roth IRA, use it to retire early with no tax or penalty.
More quick info:
The contribution limit is $5500 per person, or $6500 of you’re over 50 years old, PER YEAR.
Once you max out your Roth IRA you can put as much money as you want in a taxable brokerage account.
You can contribute for the current year between Jan 1 and April 15 of the following year (or whatever tax day falls on, if that’s a weekend). If I haven’t already maxed mine out before January 1st, I continue contributing for the prior year until April 1st to give myself as much room as possible for the next year. Your brokerage will let you choose which year to apply your contributions to during that overlapping period between Jan 1 and April 15.
If you contribute over the $5500 limit to your Roth IRA, you’ll have to pay the IRS a 6% penalty on the excess. They will come for it too, believe me.
IRA stands for INDIVIDUAL RETIREMENT ACCOUNT. You cannot own this account jointly with your spouse or anyone else, although you will need to name a beneficiary for it. This account is completely separate from your employer.
Only the money you contribute to your OWN IRA counts towards this $5500 contribution limit. This means the following does not count:
- the money your money earns in your Roth IRA
- rollovers into your IRA from other accounts
- 401k contributions
- contributions to your children’s or spouses accounts
- money you put into/invest in taxable or any other account besides a traditional or Roth IRA
If you make over $132k single or $194k married filing jointly, you can’t contribute directly to a Roth IRA, but there are ways around it.
Acorns, Stash, Robin Hood, etc DOES NOT HAVE A ROTH IRA OPTION. If you do not have a Roth IRA yet, you should open one now and invest in that FIRST.
If you own a business, you can contribute lots more to your retirement on your own with great tax benefits than you can if you’re only an employee.
You must have earned income to contribute to a Roth IRA, and by that I mean taxable WAGES from employment or self employment.
When you roll over a traditional IRA, 401k, pension, or other pre-tax account into your Roth IRA, you will have to pay taxes on the amount of the rollover, because you have not paid taxes on that money yet. Once you pay them, however, that money will grow tax free for you, then will also be tax free for your spouse and children when you kick the bucke–I mean, when Jesus calls you home.
When you roll over one of these pre-tax accounts, you have to roll it into a traditional IRA, then convert it to a Roth. You can covert it slowly over several years if you’re afraid the taxes will hurt.
As previously mentioned, you can and should buy your stocks right in your Roth IRA. But first, you need to open one!
Which type should I open?
There are many different brokerages and financial firms offering Roth IRAs. Many banks and credit unions offer them. Some are managed for you by a real person. Some are maintained by a computer, also known as a “robo-adviser”. Some allow you to choose your own investments. There are pros and cons to all types, but here are the most important considerations to opening your Roth IRA:
- Low fees
- Investment style–Active or passive
A bank or credit union: Yes, the Roth IRA you open at your bank or credit union is technically a Roth IRA and grows tax free, but the issue is that unless your bank offers brokerage services, you’ll be lacking the “growth” part. Most banks and CUs only offer savings, CDs and money market accounts. These products (at today’s rates) will not give you the growth you need for retirement and do not even keep up with inflation. Stocks and/or low fee index funds or ETFs are what you will need for a comfortable retirement.
Financial firm: I urge you to use caution when hiring a firm or licensed professional to manage your funds. If you aren’t well versed in investments, the first question you need to ask is “Will you be acting as my fiduciary?” If the answer is no, run far and fast. If the person is not acting as your fiduciary, you will be paying out your behind in fees to pay that broker’s commissions. If that person is your fiduciary, expect to pay 1% or more for that level of service. Read here for more information.
Robo-adviser: This is a great option for those who do not know how to buy stocks. Your money will be automatically invested into very low cost ETFs that fit your goals and risk, and the advisory fee is a fraction of what a living, breathing adviser would cost. For more information, read Retire 6 Figures Wealthier.
Self-directed Roth IRA at a brokerage: This type of account is where the bulk of my own retirement assets are held. This type of account allows you to choose your own stocks, bonds, ETFs, and index funds. In order to navigate this type of account you’ll need to understand how the market works…which is exactly what Zero to Investor will teach you, step by step.
The easiest way to get yours up and running is to open the robo-adviser Roth IRA that automatically invests for you. After you have that established, you can enroll in Zero to Investor and learn how to find, analyze, buy and maximize your own profitable stocks!