If we conducted a survey on mystifying personal finance tools, my guess is that a Roth IRA would land in the top five. Most of us are semi-comfortable with 401(k)s, but for some reason, the “R” word adds a whole new level of intimidation. It’s no secret that millions of successful women are missing out on this effective way to save for retirement because they don’t know how it works. And I’m on a mission to fix that! Armed with some Roth basics, we can step up our retirement games and hit the beach earlier than we ever expected.
What is a Roth IRA?
A Roth IRA is a special kind of retirement account, different from a 401(k) and traditional IRA in the way that it is taxed. Let’s break it down. When you contribute money to a 401(k), you don’t have to pay taxes until you withdraw in retirement. A Roth IRA works in reverse. The dollars you contribute today are taxed upfront, but you won’t owe any taxes down the road. Plus, when you invest the money in your Roth IRA into stocks, bonds, mutual funds, or other asset classes, it grows tax-free. And we know those gains can be pretty substantial thanks to compound interest.
To summarize — with a 401(k) or traditional IRA, you pay taxes later. With a Roth IRA, you pay taxes today, but your contributions and earnings grow tax-free. Naturally, it makes sense to contribute to a Roth if you think your tax bracket today is lower than it will be in retirement.
Am I eligible?
Unfortunately, not everyone is eligible to contribute to a Roth IRA. If you are single and make more than $133,000 in 2017, you can cross this option off your list. If you make less than $118,000, you can contribute $5,500 per year. If you make between $118,00 and $133,000, your contribution limit reduces based on an IRS schedule.
Similarly, if you are married and your combined incomes exceed $196,000, you’re out of luck. Between $186,000 and $196,000, your contribution limits phase out, and below $186,000, you can each contribute $5,500.
Should I open a Roth IRA?
If your employer matches your 401(k) contributions, prioritize those first so you don’t leave money on the table. If you are eligible and have more room to save, then I encourage you to open a Roth IRA. Here are the top five reasons why:
- Tax Benefits — Your contributions grow and compound tax-free. Let’s say a 25-year-old contributes $5,500 per year until age 60. She could have over $1 million in savings! And she won’t owe a cent of it to the IRS.
- Flexibility — If you find yourself in a pinch, you can withdraw your contributions without penalties before age 59 1/2.
- No Minimum Distributions — A traditional IRA requires you to take minimum distributions at age 70 1/2 and pay income tax. A Roth allows you to withdraw what you want, when you want, tax-free.
- Estate Planning — This may not be top of mind for younger women, but you can pass down your Roth funds. Your beneficiaries won’t owe taxes either.
- Diversified Income Stream — We know we should diversify our investments, workouts, outfits, and meals. Well, our retirement incomes are no different! If you already have a 401(k) or traditional IRA, a Roth adds an income stream with a different tax characteristic.
How do I open a Roth IRA?
While your employer has to open your 401(k), you can open a Roth IRA on your own. I keep mine with Wealthfront because it saves me time and invests according to my personal risk profile. However, you can choose to open one with a variety of brokers and IRA providers.
Now all that’s left to do is fast forward a few years. Just sit back, relax, and withdraw your savings tax-free as you sip margaritas on the beach.