If you don’t have a Roth IRA yet, never fear. This post is for you.
Let’s start with a trip back memory lane. It’s a sunny summer day in the mid-2000s. You don oversized sunglasses on the way to your minimum wage seasonal job that pays $7.25/hour.
Buy U a Drank by T-Pain is on the radio. Subwoofers *UP* at 8:00am through your residential neighborhood.
In your spare time, you consume every second of the show Laguna Beach. Unsurprisingly, most of your money is spent on gas for your 1999 Ford Taurus and mimicking Lauren Conrad’s aesthetic as closely as possible. It feels like the $250 you earned last week is burning a hole in your pocket.
You work this job for three months every summer for four years, earning a cumulative of $10,000. Since your earnings are below the standard deduction each year, you owe no taxes. You don’t even have a debit card yet, let alone know what a Roth IRA is.
But for the sake of an example, instead of becoming LC’s doppelgänger, let’s pretend you invested half of your summertime job bag in a Roth IRA account.
Within the account, you placed $1,250 per year in the stock market (in an index fund), are earning a 6% return, and leave your money invested until you’re 60 years old.
Had this been the case, that $1,250 investment you made each of those four summers could have been over $60,000 by age 60. If you never needed the money and gifted it to your children when you pass at 85, it could surpass $270,000. Both amounts are tax-free.
Meet the Roth IRA Account
A Roth IRA is a type of investment account given ~special~ tax treatment by the IRS to help you save for retirement. You can contribute up to $6,000 of after-tax dollars to the account each year.
After-tax just means it’s money that you’ve already paid income tax on, like the bi-weekly paycheck landing in your bank account. After you contribute your money, you purchase an investment, and let it grow for the long haul. 🤠
The ~special~ part? Money invested in this type of account grows tax-free, as long as you play by the rules of the IRS.
The Roth IRA is ideal for someone making a lower to modest amount of money that has time to let it grow. With it, you create tax-free retirement income.
We’ll explore some strategies for using a Roth IRA, especially if you have kids, are a stay-at-home parent, or want to lower your tax bill in retirement.
Why would I want to open a Roth IRA? The general benefits.
- Money in the account is fully tax-free to you, as long as you use it after age 59½.
- Maintain tax- and penalty-free access to the dollars you contribute at all times, even before 59½.
- There are some allowable exceptions if you’d need access to the account growth before 59½ without being assessed a 10% penalty for an early withdrawal. This includes first-time home purchases and higher education expenses, as examples. Find the full list and rules here.
- Roth IRAs are super accessible. You can open one at virtually any online brokerage platform.
- No required minimum distributions (RMDs). The IRS will never require that you take mandatory withdrawals from this type of account, even during retirement.
- There are no age restrictions to open an account. As long as you have earned income, you can contribute up to the amount you earned.
Of course, with ~special~ treatment comes rules to follow. (Stay with me here. ☕️)
- As of 2022, $6,000 is the max you can contribute per year if you’re under 50. If you’re 50 or older, that goes up to $7,000 per year.
- You need to have earned income in the year that you contribute to the account. If your earnings are less than $6,000, you can contribute up to the amount you earned.
- If you make too much money, you might not be able to contribute to a Roth IRA.
- As of 2022, if you make over $129,000 individually or more than $204,000 as a fam, the amount you can contribute may be reduced or precluded completely. If that’s you, here’s a resource for additional research.
- Plan to wait until you’re 59½ to use the money. If you withdraw before eligible, you’ll have to pay a 10% penalty. That penalty is in addition to taxes on investment growth. Yikes.
- You can’t withdraw earnings tax-free until it’s been at least five years since you first contributed to the account. This bad boy is known as the Roth IRA Five-Year Rule. It applies even if you’re older than 59½. Rarely are younger folks impacted by it since our time horizon is long.
The Fun Stuff 🤓🤑 3 Roth IRA Strategies to Grow Your Family’s Wealth
For Your Kids: Custodial Roth IRAs
Because there are no age requirements to open a Roth IRA, a custodial version of the account is ideal for getting your kids to start investing, once they have earned income. (Roths are not for gifts or birthday money!)
Because their investment time horizon is so long, encouraging your kids to invest even a small amount can turn into meaningful money by the time they reach retirement.
And remember the part about contributing after-tax money? Unless you gave birth to the golden goose, your kid is probably in one of the lowest tax brackets. They’ll be paying a low rate, if any tax at all. Money that they put into this account will never be taxed again.
Garnishing your a teenager’s wages to park them in a long-term investment is idealistic at best. I’ve been humbled by a one-year old more than I’d like to admit – and she’s bush league compared to teenagers. I see you.
But, using a Roth IRA to begin financial education early can create a positive snowball effect for their financial future. You can literally change their lives.
For the Stay-at-Home Parent: Spousal Roth IRAs
There’s an exception to the rule that you need to have earned income to contribute to a Roth IRA. Enter our friend, the Spousal Roth IRA. This account works just like a regular Roth, except the working spouse contributes to two accounts, one for each spouse.
To implement this, you’ll need to be married, filing taxes jointly. Further, contributions should be made into two separate Roth IRA accounts, not lumped into one.
This account can act as a safety net for the stay-at-home parent in your family. Retirement accounts are inherently individual accounts, which creates major inequity between couples if one fills the role as the breadwinner while the other manages the house over years.
All of those retirement assets, even if they were earned because of an agreement between partners, technically belong to the breadwinner. In the event of divorce, sure, you might be entitled to some of your ex-spouse’s assets – but, it’s a timely and expensive process.
You want tax-free retirement assets in your own name. Period.
For You: A Way to Diversify When You Pay Taxes
As a half-hearted attempt to guide readers, many financial websites include a jargony phrase like the following to explain when to use a Roth: A Roth IRA is a better choice if you think you’ll be in a higher tax bracket when you retire.
If your first reaction is, “How the hell would I know that?” you’re asking the right questions. Without knowing what your income or the tax code will be in 30+ years, it’s virtually impossible to predict.
Instead of reading the tea leaves to figure out what the future may hold, I think of Roth IRAs as a way to diversify when you pay taxes and at what rates.
The tax benefit of an account like a 401(k) or Traditional IRA is enjoyed today – you get a deduction to reduce your taxable income. Then, in retirement, you pay income tax on any money that you withdraw from these accounts.
A Roth is like the mirror image. You contribute money that you’ve already paid taxes on today. Then, in retirement, all of that money is tax-free to you with no requirements to distribute it from the government.
By having both types of accounts, you diversify when you pay taxes and at what rates.
Take us home.
Even if you’re not feeling 22, it isn’t too late to open a Roth IRA. It’s just that having a long time horizon and being in a low tax bracket maximizes its benefit. Opening one at any time will still create tax-free income for you in retirement, which is clutch.
The estimated life expectancy of millennial women is about 82 years old. If you’re 30 today, that’s about 35 years until retirement, plus another 17 when you’re likely to be using this money. We’re going to need it.
Plus, I don’t know about you, but I’m looking forward to being that rich-ass grandma.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult with your financial advisor.
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