The Ultimate Guide to a ROTH IRA

A Roth IRA

Okay, so I know what you are thinking.

“I’m too young to be saving for retirement.”

“But, Maeva I’m broke.”

“This looks so difficult and complicated.”

“What’s a Roth IRA?”

When I first started thinking about investing, I did not even know where to start. As a 19 year with very little financial experience talks of Roth IRA, Traditional IRA, 401K, mutual funds, etc. were completely foreign concepts.

Even though, I liked the idea of investing I was paralyzed by the overwhelming amount of information that was dumped on my head. I felt that I needed to hire a professional financial advisor and a brokerage firm to even begin investing.

I stumbled and fumbled my way into investing so that the rest of you do not have to. Here’s why a wealth and investment management internship in my sophomore year of college persuaded me that it’s never too early to invest and a Roth IRA is the best way to start.

This ultimate guide will provide you with all the information you need to get started with a Roth IRA and then some.

WHAT IS A ROTH IRA?

A Roth IRA is essentially an individual retirement account (meaning that you contribute to it, not anyone else) that allows you to put in money and invest while getting some tax benefits.

Contrary to the commonly held belief a Roth Ira is not an actual investment in and of itself. All it does is simply hold money that you can invest with.

Unlike the other typical accounts that also hold money, you can use the funds in this account to invest in things like stocks, bonds, ETFs, mutual funds, etc.

Even though there is an abundance of other investment vehicles out there a Roth Ira has some serious benefits that make them the perfect account for novice and experts alike.

But, let’s back up a little and learn how this came to be.

From PersonalFinanceClub

HISTORY OF THE ROTH IRA:

In 1974 the government realized that us average citizens also needed a way to save for retirement. So, what they did is pass the ERISA act, which essentially allowed the government to set up specific benefits that are associated with “retirement accounts”.

This was certainly beneficial for those whose jobs provided them with a 401K and other retirement vehicles. However, the special tax credits were unavailable to a large subset of Americans whose jobs were not as generous.

So, the federal government then decided to throw those people a bone, or should I say an IRA which extended those tax and retirement benefits to all Americans.

So, with these new independent retirement accounts came two options the traditional IRA and Roth IRA. The traditional IRA was similar to the 401k in that money was added to the account pre-tax and thus continued to grow tax-free until one retires and starts withdrawing the funds.

When you start withdrawing the money at retirement the money is taxed based on your income level. Fair warning if you take money out of this account prior to your 59 ½ birthday you could get a hefty 10% tax penalty in addition to the regular tax you’ll have to pay anyways.

The Roth IRA on the other hand (and the sole focus of this article from here on out) is post-tax money. This means that you have already paid taxes on that money prior to putting it into the account.

It also means that the money you withdraw from it in the future is also tax-free. As of 2019, you can contribute a max of $6,000 into the account tax-free.

This is great because most people tend to make less money earlier in their careers and thus occupy a lower tax bracket. This means that when you are rolling in the dough later on in life you can enjoy these tax-free withdrawals as if you were still on a ramen diet.

Check out this little chart of our friend Johnny showing the effects that a retirement account has on his savings nest over several decades.

From Fidelity.com

That’s a large amount of savings that come with a retirement account like a Roth IRA. They also come with some nice additional benefits that we will discuss later on.

Later on.

BENEFITS OF A ROTH IRA:

You can contribute how much you or how little you want when you want (up to 6,000 a day)
There is no age restriction as long as you make at least $6,000 (you might need parental permission if you are a minor)
If you get caught in a sticky situation you can withdraw the money you put in without being taxed or penalized if it has been there for at least 5 years, this is also known as the 5-year rule. (Careful, you will be penalized for withdrawing your investment earnings)
You can avoid penalties on withdrawals if you use the money for a first-time home purchase or for higher education.
You can start accruing compound interest. So, that means that you can earn interest on the interest you make.
This account is great if you think you are going to make more money in the future than you are making right now. Seeing as how most of us are or were young this definitely applies.
You do not need thousands of dollars to get started

I know at this point you are dying to start, but slow your roll and see if you qualify.

WHO QUALIFIES FOR A ROTH IRA?

As I mentioned above there is no age restriction to contributing to an IRA as long as one has earned an income of at least $6,000. Nevertheless, there are some income restrictions and for those that are bringing in some premium high-grade bacon, you may not be eligible.

As of 2020, you qualify if….

You are a single tax filer who makes less than $137,000 a year. Those making between $122,000 and $137,00 will have to contribute a reduced amount.

You are a married couple filing jointly who make less than $203,000 a year. Those making between $193,000 and $203,00 will have to contribute a reduced amount.

After looking at this you might ask, “What if I do not qualify?” Well, there is still hope and options that might make you eligible in the future.

This includes:

Having a low earning year, due to loss of job/income. Being a freelancer/independent contractor with unsteady income.
You or you’ll add enough money pre-tax income in your 401k to lower your take-home income in such a way that you become eligible for a Roth.

Now that I have sufficiently persuaded you to open an account with my brilliant recanting let us get to the meat and bones of it.

HOW TO OPEN A ROTH IRA:

The first step is of course actually opening up an account and that can easily be done from the comfort of your couch or bed (I’m not judging).

There are major financial institutions and brokerage firms like Fidelity, Vanguard, Schwab, Betterment, and Merrill Edge that all offer Roth IRA accounts. Some smaller institutions and local banks could also provide these same services.

Setting up an account should take a few minutes and then you are ready to trade. I highly recommend setting up an automatic monthly money transfer, which allows your money to grow without you having to put too much effort into it.

From InvestorJunkie

You’ll have to decide what funds you want to invest in as well. But I got you.

WHAT SHOULD I INVEST IN A ROTH IRA?

That’s a good question. All a Roth IRA does is hold your investment; it is not an actual investment. To invest you have to buy different investments. Thankfully a Roth IRA allows you to invest in a number of things like individual stocks, bonds, mutual funds, and ETFs.

If you are a young millennial or GenZ-er like me, you can afford to take more risks because you are going to be investing for several decades before you retire. This means that your portfolio should be heavier on stocks vs bonds. But you can research more funds on (insert Morningstar links) to see different combinations of stocks and bonds.

There are many brokerage firms that offer advice and guidance on a different mix of investment accounts. Robo advisors like Betterment, Wealthfront, and Acorns essentially create a portfolio for you based on what your goals are. Be on the lookout for a comprehensive review of Robo advisors.

BUT in my personal opinion, for our demographic, I would HIGHLY recommend investing in index funds. Index funds are low-fee, low-maintenance, diversified investments.

Index funds are a type of mutual fund that is made of portfolios that track a particular market index. To put it in simpler terms, index funds are packages of stocks that are meant to mimic the stock market.

Index funds are not trying to beat and outperform the markets by anticipating which stocks are going to rise and investing in them. Instead, it is simply going to mirror the markets. The reason why is that research has shown that index funds beat out actively invested firms over a long period of time.

GETTING MONEY TO CONTRIBUTE:

Trying to balance different financial goals is never easy and putting investment money towards retirement can be especially difficult when it just seems so far away and bills are oh so very present.

However, thinking, in the long run, is critically important to anyone hoping to achieve financial independence, or simply not wanting to panic when retirement comes knocking at the door.

Waiting costs money and it is much harder to catch up the sooner one is to retirement (whatever age that might be for reach individual). There will almost never be a perfect time or a perfect income to start investing.

Take it from me. I started investing before I was even making $10,000 a year and this is while I am in college working 15 hours a week and getting paid $10.

START NOW WITH THESE TIPS:

Set up a monthly transfer: this can be as little as ten dollars.
Pay yourself first: This means putting money into your investment and savings account first. Then pay your bills, then use the leftover money to do fun things.
Cut Costs: This might mean taking public transportation, getting rid of subscriptions you no longer use, renegotiating your phone plan, etc.
Find a side hustle: This does not have to be some creative endeavor; it can simply be a flexible second job that allows you to earn a little bit of money on your own time.

PARTING WORDS OF WISDOM:

Start now. That’s it, that’s the Wisdom.

THINGS TO DO:

Open A Roth IRA. Like seriously. Like right now.
If you already have one (internet high five). Make sure you try and max it out before the tax year is over.
If you are killing it and have already maxed out this year’s account, great job! Starting thinking about also maxing out next year’s contribution limits.

SUMMARY:

This guide was certainly a tour de force. The end has come for the ultimate guide to a Roth IRA. This guide covered everything from its history, to what it is, the benefits, selecting investments, qualifications, and tips on how to get started. You are now more knowledgeable about a Roth IRA and should be able to make the decision whether is it right for you (it probably is).

Although fairly ultimate if I do say so myself this post is simply meant to give an entertaining crash course on the Roth IRA. There are several things, information, regulations, etc. that I was not able to include in this blog.

Please make sure that you read, consult, and financial professional, and do not just listen to me, a stranger from the internet. I hope that you at least learned the power of a Roth IRA and the ways it can help you reach financial independence, early retirement, or both.