What Is A Roth IRA And How Much You Should Be Contributing?

What Is A Roth IRA And How Much You Should Be Contributing June 2021

In today’s day and age, we have many ways to save and invest our money for our futures and retirements. In fact, there are so many options it can be extremely stressful and confusing to pick the right one for you. Today, we can clear up some of the confusion and discuss a Roth IRA.

This IRA (Individual Retirement Account) differs in a few key areas that make it a better choice than a traditional IRA. Let’s take a closer look and break down the details.

Who Is Roth and What Is The Roth IRA?

The Roth IRA was introduced in 1997 as part of the taxpayer Relief Act of 1997.  Senator William Roth, its chief legislative sponsor along with Senator Bob Packwood established the Packwood-Roth plan that would allow individuals to invest up to $2000 at the time, in an account without any tax deductions.

Originally conceived as the IRA plus account, it is now known as the Roth IRA and has gained significant popularity since the early 2000s.

The Roth Individual Retirement Account provides you with the ability to set aside a specific amount of post-tax dollars to invest and grow without having to pay any income taxes on it upon withdrawal.

(There are some conditions to not paying any taxes on withdrawals and I will cover that a little farther down.) The amount you are able to contribute in 2021 is $6000 for those under 49 years of age and $7000 for those 50 and over. 

From this account, you are able to purchase and invest in various securities and funds just like any other investment account. Common stocks, bonds, mutuals funds, derivatives, and real estate are possible investment avenues using a Roth IRA.

As with all IRAs, the Internal Revenue Agency mandates specific eligibility and filing requirements. 

Who Can Open A Roth IRA account?

Assuming you meet the remaining qualifications, anybody can open a Roth IRA account. The first requirement is being under the income limit.

In order to contribute to an IRA, your gross income as a single filer needs to be under $140k or $208k as a joint filer. 

The second requirement in order to contribute is that you must have income from work.

The contribution limit is your work income or $6000, whichever is less.

When Should I Set Up A Roth IRA?

I’m sure it’s repeated over and over but here goes, the best time to start saving was yesterday but the next best time to start is now. Compound interest is an extremely powerful tool to build your wealth but it is more effective the earlier it is implemented.

Since there are no age restrictions on setting up an account I would urge most young people to set one up as soon as possible. It may not seem like the most exciting purchase or investment but your future selves would definitely be very proud and far better off for it.

If you still not convinced then play around with this Compound Interest calculator and check the difference between starting to save now as opposed to waiting 10 years to start. 

Key Differences Between A Regular IRA And A Roth IRA

Traditional IRAs provide an immediate tax break and can be very appealing, however, if you are looking for tax-free income in your retirement then a Roth IRA is the way to go. Traditional IRAs and 401(k)s can lead to tax bills in your retirement upon withdrawal and cut into your savings.

Additionally, for those who don’t need their retirement savings, a Roth IRA will allow you to pass the assets to heirs tax-free upon death, while a regular IRA would require the beneficiary to pay taxes on the distributions.

Ultimately, choosing a Roth IRA or a traditional IRA will usually boil down to one main factor, the tax bracket the filer falls under. A lot of people switch over to a Roth IRA in fear of taxes hiking and by doing so lock in the current tax rate for their current contributions. 

How To Open A Roth IRA Account

Choose Your Financial Institution

If you are convinced and made the decision to open a Roth IRA then you may be wondering where to go next. Luckily most brokerages and banks offer Roth IRA accounts and there are plenty of online financial institutions that would also love to set you up with an account.

Choosing online institutions over brick and mortar banks can be more beneficial for those looking to invest in stocks and bonds as online institutions generally have more access to a larger market than brick and mortar banks. 

When choosing a financial institution you most likely have 4 major choices, Banks, Traditional Brokers, or Online or Robo-Advisor.

Banks

US Banks June 2021

If your bank has a good online banking system, and you are able to set up a Roth IRA account through your bank while also having easy access to buying stock and bonds I would suggest setting it up with your bank to keep all your funds as close together as possible.

I like using my banking institution for my Roth IRA because I have been a long-time customer and if I need help or assistance I can always go down to my local branch and get personalized help to solve my problems.

Good customer assistance is often overlooked but tends to come up quite quickly when problems arise. 

Traditional Brokers

Traditional Brokers offer a more active approach to choosing your investments and are a good option for those most involved in the markets who trade frequently. Many banks will have an online banking system as well as an online broker.

These brokers generally offer a larger scope of the market and allow for more freedom in choosing your investments. With more freedom comes greater risk so be careful and do your due diligence before choosing your investments.

Remember to no trade emotionally and back up all your decisions with reliable information. 

Online

As mentioned, many online institutions offer Roth IRA accounts and can be a great option for younger and tech-savvy generations. The sooner you get started saving the better off your retirement investments will be and starting right out of high school can lead to some serious compounding interest.

Online institutions lack the brick and mortar overhead costs and as such are able to offer a more diverse set of options for investing your funds. If you are interested in some more obscure and less traditional investments then online institutions may be the only way to invest in those exotics.

Apart from a more diverse set of investment routes, online institutions differ mainly in not having physical locations to visit. This can be a big downside to those who prefer in-person interaction to get their information. 

Robo-advisor

Robo Advisor June 2021

As part of the online services many institutions offer, you have the option of a more hands-free approach to investing your IRA by using Robo-advisor to choose your investments for you.

This automated investment computer can help you diversify and allocate your investments better than those learning for the first time.

This is a fantastic option to those who want to buy stocks and bonds but don’t know enough to get started right away.

Using a Robo-advisor to jump-start you as you slowly pick up information and learn your way around the market is a luxury many people did not have a few years ago is incredibly beneficial to those less knowledgeable about markets. 

Some Robo-advisors are few but it is often worth a small monthly or yearly payment to have a computer handle your funds more effectively. 

Contributions And Depositing Your Funds

You can deposit a lump sum or add smaller amounts over time to your Roth IRA account. The limit to your contributions in 2021 will be your yearly taxable compensation or $6000 ($7000 if over 50).

It is also possible to add money into a Roth IRA account by rolling over funds from another retirement account into this one. Contributions are reset every tax deadline and not at the end of every year. This means you can contribute for 2021 for a few months into 2022. 

Depending on your choice of in-person or online account set up the process for depositing funds will vary slightly. For brick and mortar banks you can go and deposit into your account through the bank or broker.

This is usually the simplest and easiest way to go about it. Those online or with no access to in-person help have to transfer money online through either wire transfer, direct deposit, or a few other options.

With Covid-19 keeping everyone in lockdown almost all major businesses have made a major transition into online portals and as such the process is a lot more simplified and easier compared to pre-covid times. At least there is a small upside to the virus keeping us indoors.

Withdrawals And Distributions From Your Roth IRA

Withdrawing and distributions from your Roth IRA account have a few conditions. Make sure you take a close look and understand where you put your money and the restrictions on it before making the decision to do so.

  1. 1
    It is possible to withdraw your original contribution whenever you wish without any penalties or taxes. This applies no matter how long the account has been open for as this is money that you have already paid income tax on. 
  2. 2
    When withdrawing funds from your IRA the IRS assumes that your original contributions are withdrawn first. This can be an important detail in maintaining and contributing the maximum allowable deposit into your Roth IRA. 
  3. 3
    There are conditions to pulling out investment earnings from the account tax-free. Those who are at least 59.5 years old and hold the account for at least 5 years are able to take distributions, including earnings without worrying about federal taxes. Any withdrawn earnings that don’t fall under this rule will be subject to taxes by the IRS. 

Should You Set Up A Roth IRA? 

Roth-IRA-June-2021

YES! What are you waiting for?! Understandably, it can be difficult to put money aside for savings, especially during these difficult times.

If possible, try and get into the mindset of “buying” a better retirement now by using money that normally would go towards material objects and instead of contributing it to your savings.

To recap here are some reasons I believe most people should be saving and maxing out their Roth IRA contributions.

NO Age Limit

This is a huge factor. Compound interest in incredibly powerful and starting your savings as early as possible will help you in ways you can’t imagine right now. Young people should be especially interested in getting one of these accounts started, even if you can’t max out the contribution limit. 

NO Minimum Contribution

As mentioned above, even if you cannot contribute the entire amount, having even a little bit of money gathering interest is better than none. Time is your ally in this case. 

Double Savings

For those who really like to save and can do so, the Roth IRA can be used in addition to using a 401(k). Extra contributions now mean less headaches in your retirement. 

Tax-Free

This shouldn’t be so low on the list but TAX-FREE! After 59.5 years of age and 5 years of account ownership, all your withdrawals are tax-free and you no longer have to worry about paying the government.

Easy Withdrawals

Pulling out contributions in case of emergencies is simple has no restrictions or taxes. If you are struggling, and find you need to dip into some savings, this can be a way to grab a little extra cash without taking out high-interest loans. 

The Roth IRA is an incredible tool for building your retirement wealth, especially for younger folks. I urge everybody to take a closer look at whether you qualify, try out the compound interest calculator, and get excited about your retirement potential! 

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