Have you set up your Roth IRA yet? Do you even know what a Roth IRA is? You should, because this little retirement investing gem could make your life 100x easier down the road.
Basically a Roth IRA allows you to save and invest your money tax free. Not only does your money grow tax free, but it is also tax free when you eventually withdraw it (presumably in retirement). To make it even more attractive, you can invest in nearly anything within a Roth, so you aren't restricted to just stocks and mutual funds.
The Roth IRA can benefit investors of all ages, but they are particularly good for young investors thanks to the long time horizon. And their flexibility means you can diversify your retirement savings by investing in real estate, bonds, ETF's, stocks and even commodities. Used properly a Roth IRA can mean a very comfortable retirement, without the need to worry about cash or the tax man.
Roth IRA When in Your Twenties
Here's an example of the benefits for a young saver:
Say you've just graduated from college and you've got your first job. Congratulations! If you decide to start a Roth IRA now, at the age of 22 or 23 and fund it fully ($5000 per year as of 2012), how much money do you think you will have by retirement at 65? If you can get a very conservative 6% return on your money over the next 43 years you will have amassed a fortune of $993,790.
By contrast, if you had invested that money in a taxable account it would have only grown to $654,569, a difference of over $300,000! It gets better though. Because your nest egg is in a Roth you can make withdrawals tax free AND the balance continues to grow tax free. Not true if you have a taxable account, where you will continue to pay taxes on any capital gains and dividends.
You also get several other benefits by using a Roth IRA as a retirement savings account.
- You can make withdrawals of any contributions at any time tax and penalty free. While you should always refrain from taking money from your retirement savings, it can be a nice cushion if an extreme emergency befalls you or your family.
- You can take up to $10,000 of the earnings in your Roth IRA tax and penalty free if you are using it to buy your first home. Again, taking retirement money isn't your best option, but in this case it is akin to moving assets from one account to another.
The only caveat is that you must have had your Roth for a minimum of 5 years. If you can't meet the 5 year test you can still withdraw your earnings, but you will have to pay normal taxes on them. The withdrawal is however penalty-free.
- You can use the Roth to save for your children's education.
Not Eligible to Contribute
Unfortunately some people are not eligible to contribute to a Roth. Once your income reaches a certain level you are no longer allowed to contribute to a Roth. You do not have to withdraw any money currently in a Roth you may have opened earlier, but you are no longer eligible to make additional contributions.
Phase outs to the contributions begin at $110,000 for single filers and $173,000 for those who file married jointly. Upper limits are $125,000 for single filers and $183,000 for those married filing jointly. If your income is above those limits you simply can no longer contribute to the Roth IRA.
So, unless you make too much money to contribute there are no good arguments I can think of not to fully fund a Roth IRA. Oh, and if you are married, both partners can fund a Roth IRA, meaning your yearly limit is doubled to $10,000 total. Those contributions are pretty small now, but can grow to a huge nest egg down the road.
Author bio: This is a Roth IRA guest post from Steve at Money Infant.