In this retirement funds series, I’ve covered The 401k plan that your employer might offer and that you should be enrolled in. If your employer does not offer a 401k, you have other options such as a Roth IRA. This will ensure you are able to invest to your retirement and ensure you are taken care of by the time you get there. Let’s see what our options are with IRAs.
What is a Roth IRA
A Roth IRA is tax-advantaged individual retirement account, thus the name “IRA”, that allows you to contribute to your retirement plan and is NOT taxed upon withdrawal at retirement age (59½ or later). It is important to note that your contributions WILL be taxed initially, but not at withdrawal time.
There are two types of IRAs, one is a traditional IRA, and a Roth IRA which we’ll primarily be focusing on.
With a traditional IRA, any contributions you make are tax-deferred, meaning that you won’t pay taxes until you withdraw the money at retirement time. The benefit of a traditional IRA is that your money will grow tax-deferred (similar to a 401k); therefore, maximizing your potential gains until you retire. It is important to note that you will eventually pay taxes at the time of withdrawal, and there is a 10% penalty fee if you withdraw before your retirement age, in addition to taxes, and standard income tax.
As mentioned earlier a Roth IRA is similar to a traditional IRA, but different in which it is not tax-deferred at contribution. This means that you will pay taxes when you contribute to your Roth IRA, but will NOT pay taxes at the point of withdrawal during retirement.
How much can I contribute to my Roth IRA?
Once you enroll in a Roth IRA, you may contribute up to $6,000 yearly (as of 2021). If you are older than 50 years old, you may contribute up to $7,000 as a catch up contribution.
However, if you make more than $140,000 and file taxes as single, you won’t be able to contribute to a Roth IRA. This also applies if you’re married and make more than $208,000 combined income, you and your spouse won’t be able to contribute. If you make too much money, there are plenty other ways to invest and diversity your funds so don’t worry. We’ll cover that in another article.
Here’s an example of someone who starts investing $3,000 at age 30 and contributing $6,000 yearly to their Roth IRA in a period of 35 years. Historically investing in an index fund will grow an average of 8% so we’ll use this number as our annual growth. By the time this individual is 65 years old, their account would have $1,078,257 making this person a millionaire by the time they retire.
You can calculate your own Roth IRA growth here or here.
How do I sign up with a Roth IRA?
If you have an existing employer-based 401k account with a specific financial institution and would like to open your Roth IRA there to make it easier, then that might be a more convenient option as you’ll be accessing it via the same interface.
However, if you’d like to open your Roth IRA account with a separate financial institution, here’s the list of some of the ones that are trustworthy and that I’ve used in the past. Note: There are many other financial institutions that you may open your Roth IRA with, I’m not suggesting that these are the only ones.
You may easily search online on “how to open an Roth IRA account with x financial institution”. Here’s an example of a YouTube video of someone going step-by-step on opening a Roth IRA account with Vanguard.
Here’s typically the things you’ll need to sign up for a Roth IRA
Full Name & Details – Address, Social Security #, Birthdate, Email, Citizenship status.
Bank Funds – Your bank account where your funds will be transferred from
Money Goal – Are you looking for Growth, Capital preservation, etc.
Review and e-sign
The process will take anywhere from 48-72 hours as the money will take some time to transfer from your bank to the financial institution you’re signing up for your Roth IRA.
You can get started with as little as you want; however, I would recommend starting with $3,000 so you may invest in specific index funds such as VTSAX from Vanguard, or any other ones that have a minimum. Again, do your own research and see how much you’d like to get started with.
When can I withdraw my money?
You can withdraw your contributions without tax or penalty at any time; however, when it comes to earnings – that is money made from the IRA contributions, you’ll be subject to income tax and a 10% penalty depending how long you’ve had the account. There is also a “5-year rule” which allows you to withdraw from your earnings without penalty/tax after 5 years.
There are other exceptions in which a person can withdraw their money without incurring the 10% penalty such as buying your first home, disability, etc..;however, I will let you dig into that information on your own as I don’t condone withdrawing the money.
Always, always, always! Remember that your Roth IRA is for retirement purposes. People will often be tempted to withdraw the money before the retirement age which is not a good idea. You will miss out on years and years of compounded interest; therefore, don’t touch your money if you don’t need to. Again the best thing to do is wait until you reach age 59½ and can withdraw all of your money tax free!
Maxing out your retirement funds such as 401k, Roth IRA, and HSA will allow you to increase your wealth over time and retire without worrying about money. No one wants to be past retirement age and working due to unforeseen events such as health complications, or lack of savings. Additionally, if you love your kids, do them a favor and plan for your future so you won’t become a financial burden once you become old. It is something very important to me and my family and I believe you should do it as well.
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