When you think about retirement planning, you may feel right, particularly if you contribute part of your monthly paycheck to your 401(k) program funded by your employer. You may even have dreams of growing old by the ocean or tapping some global travel into your bohemian side.
But instead of scraping the bottom of your savings accounts, you need to be well trained to truly live the retired life you dream of. While a 401(k) is a great start, there are other resources you can use to diversify and optimize your savings on retirement.
It is here that a Roth IRA comes in.
Not only can this tax-friendly retirement account boost your retirement money but it can also help relieve your future tax burden. An IRA comes with a few rules and some eligibility requirements added to it. But, when used wisely, it can really work for your good when it comes to retirement time.
We’re going to take you step by step through everything you need to learn to ensure you’re eligible and use a Roth IRA to its fullest.
A Roth IRA is an individual pension account you are contributing after-tax dollars to. Which means you won’t be able to take a deduction as you would with some other retirement accounts, the year you contribute.
Then, when you withdraw funds during your retirement, you get to avoid paying taxes.
This can be extremely beneficial as the money you are adding to a Roth IRA will expand (ideally substantially) between putting cash in and starting to take it out. But since you paid taxes about it the first time around, you don’t have to do it again, even though it’s a bigger amount.
You can choose the assets to put your Roth IRA funds in, such as: Individual stocks, Mutual Fund, Shares, Options (although this would be part of a more aggressive investment strategy)
How does a Roth IRA work?
A Roth IRA comes with many tax benefits, which is why these days it is so common. Even if you’ve got a 401(k), that’s a wonderful tax-advantaged contribution to your pension plan. And if you are self-employed or do not have a 401(k) at work, then investing in your retirement goals is a good start
How much can you put into a Roth IRA?
So long as you meet certain income requirements (which we’ll talk about in the near future), you can contribute up to $6,000 a year to your Roth IRA. If you’re at least 50 years old, that number jumps to $7,000, helping you catch up financially and get ready for retirement quicker.
Plus, when you reach 70 1⁄2 you don’t have minimum Roth IRA contribution limits so you can use the Roth IRA as a way to give your family an inheritance.
Ready to take early retirement? A Roth IRA could help.
Once you hit the traditional retirement age you will start making tax-free and penalty-free IRA contributions because you have already paid taxes. Nonetheless, you do have to pay taxes and probably fines on your income if you take your money out early.
When you hit 59 1⁄2 and have had the account open for at least five years you can take tax-free withdrawals on all of your assets.
Besides, Roth IRAs are not only for retirement purposes.
You can also use the funds to spend on professional education without having to pay fines or taxes. So you can help pay for the college tuition of your own or your child just as you would with (or besides) a 529 program.
Although there are contribution limits, when you choose a Roth IRA you get plenty of flexibility. And when you have financial goals at any stage of life, flexibility is important.
What makes a traditional IRA different from a Roth IRA?
Whether you know the retirement terms at all, you may have heard of an IRA before. But a few key differences exist between a Roth IRA and a conventional IRA.
Traditional IRA vs Roth IRA
When you pay your taxes the biggest difference is. A conventional IRAs, unlike Roth IRAs, allow you to take a tax deduction the year you actually make a contribution. So if you’re trying to drop your overall tax bill into a lower tax bracket or increase it, your typical IRA contribution will help you do that.
There’s one catch, of course.
If you start taking deductions if you retire, you will have to pay the full amount of taxes–including your earnings. But that is not a bad thing, necessarily.
You may expect your annual income to drop when you retire if you are established in your career and already earn a lot of money. You probably won’t withdraw all of your balance at once, so your tax rate may not be that high compared to where you are now.
When it comes to making withdrawals from your account, you will start taking the required minimum distributions once you reach 70 1⁄2 years of age. The minimum amount is based on an IRS formula which compares your age with your life expectancy.
If you want to take money out of your traditional IRA before you reach the age of 591⁄2 you will have to pay a penalty of 10 per cent in addition to your income tax.
Still, like most investments, having a diverse mix of goods is good to help you now and in the future. You might want to consider having both a traditional IRA and a Roth IRA, particularly if you want to start lowering your federal tax burden annually.
What are the requirements to be eligible for Roth IRA?
Sadly, limitations are imposed on opening up a Roth IRA especially for high-income earners. You may be limited on how much you can contribute, or you may not be able to make any donations at all, depending on how much you do. You can also just add accumulated money to a Roth IRA.
Where do cutoffs begin, then? Let’s look first at the single tax filers.
You’ll be allowed to make the maximum contribution for single tax filers and household heads if you receive no more than $137,000. If you earn between $122,000, and $136,999, you can contribute a reduced amount. Nevertheless, if you receive $133,000 or more you can not make any contributions to the Roth IRA.
Let’s look at those married filing together now.
When you earn up to $203,000, and a reduced amount when you earn between $193,000 and $202,999, you will make the maximum donation. When your annual income hits $203,000 or higher, you are not eligible for anything to contribute. Your updated gross adjusted income (MAGI) is used to determine eligibility for IRA.
It may be worth opening a Roth IRA as soon as possible, depending on your expected income trajectory over the course of your career. In this way, not only do you ensure that you contribute as much as possible while still meeting the requirements, you also give your investments as much time as possible before you are ready to make their withdrawals.
And as you can use a Roth IRA for a wider range of reasons than other forms of retirement accounts, in the future you will be allowing yourself greater financial versatility. It’s not just about setting up and making one donation every year until you retire. Alternatively, a Roth IRA can be an active part of your financial plans for the short and long term, such as going back to school or early retirement.
How do you open a Roth IRA?
You’re doing your financial business just about anywhere, whether it’s in a bank, credit union, online broker, or even a robo advisor. Compare your options to ensure low fees and good customer service are available.
Additionally, look for commission-free mutual funds with no transaction fees and ETFs. Many financial brokers also charge these fees at high prices, so it’s important to make sure you choose one that will save you money in the long run. After all, those fees can really begin adding up to handling your Roth IRA over decades.
Some brokers do allow you to roll other accounts (both conventional and Roth) into your IRAs. If this is a service you may need somewhere down the road, make sure your IRA broker is adequately professional to handle that.
For example, other robo-advisors may not consider rollovers. And if you’re leaving a job where you’ve had a 401(k), then you’ll want to make sure you’ve got to place it somewhere once you’re home.
You will find a convenient, low-cost way to manage your Roth IRA over the years, with a bit of research and contrast.
Where do you open a Roth IRA?
You will need to pick a brokerage firm to open a Roth IRA. You might be able to do this at a financial institution that you are currently working with, or you might be able to explore other choices. Online banks as well as brick and mortar may act as brokers. It really depends on where you want your investment to be located and what kind of fee structure you want.
Start with a bank that you are already using, but don’t be afraid to compare its services and fees with other financial institutions. Maximizing your earnings is critical, so that you can retire comfortably.
How do you keep your Retirement Account under control?
How exactly do you need to do when you have a Roth IRA opened? You want to continue with making contributions, obviously. You can use a conventional 401(k) or Roth IRA to rollover savings, but you will be required to pay taxes on that money so make sure you can accommodate the extra financial burden.
Remember also that prior to the tax filing date of the next year you can still make a contribution and still have it credited for the previous year. For instance, if you don’t contribute the full $6,000 to your Roth IRA before December 31, 2019, you actually have to make your 2019 contribution before April 18, 2020 (the day the federal taxes are due).
It’s time to decide how you want to invest that money once you start investing your Roth IRA, just like you would with any other fund. The level of risk and diversity that you choose should be based on your own risk tolerance and your age. You will choose much more aggressive investments if you are in your 20s than if you are in your 50s.
Experts recommend either index funds or ETFs for a low cost strategy, which allows you to buy stocks and bonds that mirror broader markets.
A Roth IRA can be an effective part of your pension strategy, especially considering all the tax benefits that come with it. Consider all of the options available to you for the most successful retirement savings plan, then see how each piece fits into the puzzle. When you reach retirement inch closer and closer, constantly reassess how you spend your money.
For example, if in the next couple of years you expect an increase or promotion that will knock you out of the income range to contribute to a Roth IRA, it may be prudent to maximize your contributions as long as you can. If you are getting a job with an employer that matches your 401(K) contributions, make sure that you take full advantage of that opportunity.
Constant reassessment is necessary to ensure that you benefit as much as possible from your retirement resources. And you want to make sure you are looking after your investments now and in the future. A Roth IRA is really a choice, because no matter where you are in today’s life, you can allow yourself plenty of space to move around anything that comes in life.