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What is a Roth IRA in basic terms?

 It is a tax-advantaged retirement account that lets you avoid taxes while the investments within it, and when you withdraw from it in retirement grow as long as it is invested with earned income. 

What does that mean?.. Elaborated

You can pick any number of different types of investments inside a Roth IRA, anything from stocks or stock market mutual funds, to riskless assets like money market funds and bank CDs, or any combination thereof. However, you can only contribute $6,000 per year to an IRA, and if your income is too low or too high your contribution space may be reduced or eliminated. Earned income can include wages, salaries, tips, and some sort of W2 or 1099 income.

This amount put into the Roth is NOT deductible from your yearly taxes like the others and your money grows tax free for an unlimited amount of time. You NEVER pay any sort of tax on any of your gains or withdrawals forever.

What do I do/ How do I start?

Charles Schwab, Vanguard, Fidelity, and other low cost brokers are great resources to sign up and begin your account with. Open a Roth account as soon as possible. You can start small, but try to start with at least $500. Add as you can, but the contribution limit is up to $6,000/year. It must be ‘earned income‘, not dividends or royalties. This is one of the best-rated retirement plans, as it gives out tax-free earnings and benefits.

What is the difference between a Roth IRA and a traditional IRA? What are some benefits?

In reality, assuming stable tax rates, the tax-free growth on Roths vs conventional IRAs is virtually worthless (big assumption, granted, but for most people, they have a lower tax bracket at retirement anyway). Both, of course, contrast with taxable accounts. Capital gains taxes are avoided in both Roth and regular IRAs. With an IRA, you may get back 15% of your initial investment! Roth IRA, you can choose WHATEVER you want to invest in vs. in a 401k – you have to go with whatever funds or investments that your employer has chosen through their 401k provider, which typically are mutual funds with higher expense ratios (fees)

Roth benefits: If you’re already reaching your retirement objectives with your 401k, you may cash out your contributions at any time, giving liquidity for medium-term goals (monthly vacation, home purchasing, etc) while avoiding taxes. You donate after-tax money to a Roth so you don’t have to pay taxes when you withdraw money (this will lead to no penalties as well from withdrawal). The main advantage is that you don’t have to pay taxes on your profits (which should make up the great majority of your 401k value by retirement).

Traditional IRA benefits: The phaseout starts at just $62k, thus there is a greater phaseout. You may even use up to $10,000 of your profits to buy a property for the first time. IRAs are usually supplemental to 401ks and can serve as a smaller alternative as well as if 401k is unavailable to you. You contribute pre-tax to a conventional 401k, and when you withdraw at retirement, you pay income tax on all withdrawals (including earnings) depending on your current income level.

What is in my Roth IRA? Is there an income limit? Are there loopholes?

Some contribution limits are if you are below the age of 50 then you can only add in a maximum of $6,000, but if you are over the age of 50, you may begin to add in up to $7,000. The tricky thing about the Roth IRA is that as of 2021, there is an income limit of $139,000. This means that if you are a person making more than an annual $139,000, then you are not allowed to contribute to a Roth IRA. HOWEVER, there is a loophole to this ‘rule’. You may look at some youtube videos about the loophole which is called “backdoor IRA” . This basically means that you can contribute to a traditional IRA, and pass that over to a Roth IRA.

Tips in Investing in my Roth IRA?

Some straightforward advice in what you can start investing in, if you are just starting out and in your late teens to 20s, is a simple 40-40-20 ratio. 40% VTI, 40% VEU, and 20% BND, which can allow you to take some risks, not have to manage on a daily basis, and gives you exposure to the stock market. As you move forward in your investments you have to make decisions based on what will suit you the best! Do not try to take on too much to the point you are overwhelmed and confused in the process. Your portfolio can begin by investments in ETFs (do not have to be managed often and tax-free gain from dividends), Individual stocks (tax free!), Bonds (good and safe investments in your Roth IRA), and Real Estate Investment Trusts (obliged to distribute 90% of their profits to its stockholders as dividends, but in Roth you are protected from taxes creating a ton of value).

How should I pick investments for my Roth IRA?

  • Assess your risk tolerance (conservative, aggressive, etc)
  • Identify the type of investor you are (passive vs active)
  • Pick investments that are beneficial for your Roth

What is are some mistakes I can avoid?

  1. Withdrawing Early- You want to avoid this, as any profit you make from earnings within your IRA will cause a 10% penalty. You can however withdraw direct contributions without penalties.
  2. Guessing on Investments- Even if you think you are super great in taking risks, or if it has worked out for you, the Roth is not a place for taking unnecessary risks. It is not about the timing of the market, but more about the time IN the market. Getting rich, or having a secure retirement account needs to be a slow and steady process, as there is a ton of power in compound returns (capital return rate within a period of time).
  3. Over-contribution- If you accidentally contribute past the $6,000 limit, you will be taxed at 6% per year until you correct it. If you find yourself in a scenario where you are contributing too much, you should withdraw any excess contributions, as well as the gains on them, out of the account before filing your tax return.

It is so important to be in check with your Roth IRA. If you have more than one Roth IRA, be sure to periodically put in time to make sure everything is still aligned with your short-term and long-term goals. Do not miss out on this opportunity while you are young and get to investing TODAY!! There is no reason to not go ahead with the opportunities that lie ahead and help your future self and future family be secure. Goodluck and have fun (less risky fun) in all your future endeavors!