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What is a Roth IRA?
What is a Roth IRA?
IRA stands for individual retirement account. It's a saving account that you can use to invest for your retirement. The account has a few tax advantages that makes it an attractive way to save for retirement. When I am analyzing investment options, I like to list out the Pros and Cons.
Pros:
Pros:
Roth IRA accounts grow tax free. Unlike traditional retirement accounts (401K, 403b, etc.), you contribute to this account with post-tax money. This means you can't deduct this amount on your tax return. Since you are already putting your post-tax money into this account, you will not be taxed again when you withdraw the money.
You can withdraw the principal that you put in anytime without any penalty. Earnings are taxable and subjected to penalty, if it is not a qualified withdrawal. This allows for more flexibility for when you are saving for retirement as you can take some of the money out without penalty. You can read more about the withdrawal rules here: https://www.schwab.com/ira/roth-ira/withdrawal-rules
You can contribute indefinitely. Unlike traditional IRAs, you can continue to contribute to your Roth IRA even after you reach age of 70.5 years old. There isn't any rule to start withdrawing at a certain age. That way, you can continue to let your investment grow tax free.
Cons:
Cons:
Low maximum annual contribution amount. For 2020, you can contribute up to $6,000 or $7,000 if you are age 50 or older. This is not necessarily a con, but if you want to invest a large amount to your Roth IRA so your earnings can grow tax free, you are not able to as there is an annual contribution limit. This means if you have excess money left to invest, you will need to look into other investment options (traditional 401k or brokerage account).
Income limits. If you earn a lot of money, you may not qualify to contribute to a Roth IRA. For 2020, individual filer needs to earn less than $124,000 or married filer needs to earn less than $196,000 in order to contribute. If you earn more than those thresholds, you will either be able to contribute partially or not at all to your Roth IRA. You can refer to following site for information: https://www.fidelity.com/retirement-ira/contribution-limits-deadlines
Roth IRA contributions are not tax deductible. Unlike traditional IRAs, you cannot deduct the amount you contributed when you are filing your tax return. Depending on your tax situation, you may want to take advantage of traditional IRAs before putting money into your Roth IRA.
How do I start?
How do I start?
Opening a Roth IRA is very simple and can easily be done online.
I recommend Vanguard (https://investor.vanguard.com/home/) as their investment options usually have very low fees. You simply create an account, determine how much money you want to contribute to that account, and invest that money in stocks. I am a big fan of index funds, because I am not smart enough to pick individual stock winners. I just stick with the index fund: VTSAX which is a total stock market index fund that has a nice mix of different large, mid, and small U.S. companies. I had previously also chosen target date funds like VFIFX (Vanguard Target Retirement 2050 Fund). These target date funds are nice because as you get closer to the retirement age, your portfolio will be more and more conservative. Since near your retirement age, your focus would be in wealth conservation instead of wealth growth.
For those who are not as hands-on or don't want to spend too much time researching, there are other options as well. When I first started looking into retirement options, I signed up for Betterment (https://www.betterment.com/) Betterment an online investment company that specializes in their roboadvisors. Unlike Vanguard, Betterment creates the portfolio for you by picking various index funds and bonds. In order to create the portfolio, the website will ask you different questions to determine the allocations of the investments. There is a managing fee on top of the usual fees from the index funds that is charged so it is slightly more expensive than the do-it-yourself option.
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