The Ultimate Cheat Sheet for Investing with a Roth IRA

With so many retirement options and investment opportunities available, selecting the correct one can be a struggle, especially if you don’t know where to start.

If you are leaning toward opening an IRA, you might think that opening a traditional IRA is your only option. There is another savings opportunity and it features tax-free growth on your investments.

Roth IRAs are flexible and beneficial retirement accounts that may be the right fit for your investment goals. If you are interested in learning more, here’s the ultimate cheat sheet to help you understand Roth IRAs.

What is a Roth IRA?

A Roth IRA is a retirement savings account that offers tax-free investment growth, rather than the traditional IRA’s tax-deferred growth. While you don’t get a tax break upfront on your contributions, you won’t have to worry about paying anything in the future.

Any account withdrawals after you reach retirement are tax-free; you won’t have to pay anything on your distributions. This option is excellent, especially you expect to pay higher taxes when you reach retirement. Everything is paid upfront, so your investments can grow without having to pay a fee in your golden years.

Roth IRA Benefits

Aside from tax-free withdrawals, there are many additional benefits to opening a Roth IRA. For instance, you can withdraw the money you contribute at any time without fear of taxes or penalties. Since you’ve already paid the taxes on your contributions, there’s no penalty for removing them.

Keep in mind, however, that you cannot remove any investment earnings without penalty. Essentially, you can remove what you’ve put in, not the earnings you’ve accumulated.

In addition to opening a Roth IRA, you can have a concurrently have a 401K. As of 2020, the Roth IRA contribution limit is $6,000 per year, or $7,000 if you are age 50 or older. This can help you invest more, especially if your place of employment offers a 401K plan.

Another benefit of opening a Roth IRA is the freedom to decide when and how much you contribute to your fund. You can contribute any time from the first day up until the tax deadline date, which is April 15th, 2020. You can put the maximum in one full lump sum, or you can make small contributions throughout the year.

When it comes to retirement, if you’ve held your account for at least five years, at age 59 ½ you can start to take tax-free distributions, including any earnings you’ve accumulated. Also, there are no required minimum distributions, like with traditional IRAs.

Your Roth IRA can continue to grow for as long as you desire. You can decide to open a Roth IRA at any age as well, as long as you have earned income. But you cannot contribute more than your earned income.

Roth IRAs: How do they work?

Much like other retirement funds like 401Ks and traditional IRAs, the money you invest in your Roth IRA grows over the life of your IRA, only it grows tax-free.

Roth plans tend to be more flexible than other retirement options, allowing multiple different ways to fund your retirement. You can build your fund by making contributions, spousal IRA contributions, transfers, or rollover contributions.

Contributions can be made in many ways. You can open at a brokerage, bank, or go the self-directed route. You can invest in stocks, bonds, mutual funds, or exchange-traded funds.

Self-directed Roth IRAs have even more investment opportunities ranging from private lending to real estate. You can make your contributions all at once or make smaller deposits over time.

While the rule overall is that account holders must have earnings, there is one exception to this rule. For a married couple that files jointly, if one spouse is not working for pay, they can contribute to a spousal IRA.

As long as the contributions don’t exceed the spousal limit for taxable compensation, both spouses should be able to save. The contributions are limited at $12,000 and each spouse can contribute $6,000 each. If both spouses are age 50 or older, the peak limit is $14,000 with a split limit of $7,000 each.

Are there any restrictions?

Ah yes, there is always a catch. To be eligible for a Roth IRA, you must earn an income from work, aside from the exception above with the spousal contribution. Additionally, you are not eligible for a Roth IRA if you earn too much.

Those married, filing jointly, have an income limit of less than full $196,000, or partial from $196,600 to less than $206,000 yearly. For those married and filing separate tax returns, the limit is less than $10,000.

Finally, those filing as single have a full limit of $124,000 or a partial ranging from $124,000 to less than $139,000. These numbers are determined by your modified adjusted gross income for the year.

The Difference: Roth IRA vs. Traditional IRA

When it comes to breaking down the difference between traditional IRAs and Roth IRAs, the answer is clear. Traditional IRAs have an upfront tax break and your contributions grow tax-deferred over time. Once you reach retirement age, investors must pay taxes on all withdrawals based on their income bracket at the time. Additionally, traditional IRA owners must take RMDs (Required Minimum Distribution).

However, there is no income limit.

Roth IRAs, on the other hand, grow tax-free over time. Account-holders are not forced to take RMDs upon retirement, and they do not pay taxes on withdrawals.

However, there is no upfront tax break, account holders must hold a position of work, and there is an income limit when opening a Roth IRA. As you plan for retirement, it’s important to weigh the options available and make the choice that will benefit you most in the future.

Concluding Thoughts

Roth IRAs can be an essential tool for building your nest egg. Before investing or opening a Roth IRA, perform your due diligence and speak with a financial advisor to see if Roth IRAs are the right fit for you and your retirement plan. Take advantage of tax-free savings and discover what Roth IRAs can do for your future.