Reasons To Go Roth IRA

The Roth IRA is, in my opinion, the best type of investment account on the market. I have referenced the importance of a Roth IRA multiple times but have never broken down what makes it truly special. Many of you have asked what the qualifications are, how you open one, and why I feel so strongly about them. Today, I'm going to be breaking down the reasons to get a Roth IRA:

1. WHAT IS A ROTH IRA?

A Roth IRA is an Individual Retirement Account that is named after the Senator who pushed it into legislation, William Roth. It was established in 1997 as part of the Taxpayers Relief Act. The goal of the Roth IRA was to allow funds to grow tax-free and this made it a one-of-a-kind investment opportunity. Until now, all investment accounts were taxed the year in which they grew (broker account) or they were taxed when the funds were withdrawn (401k, traditional IRA). For the first time, you could withdraw funds that were entirely tax-free!

2. CONTRIBUTIONS

Contributions to a Roth IRA are funded with after-tax dollars whereas other investment accounts such as a traditional 401k are funded with pre-tax income. With a 401k, it is your company’s responsibility to pull those fund from your paycheck, with a Roth IRA, it is your responsibility. This is a significant difference. In your 401k, your income has not been taxed, but it will be taxed when you go to use it (when you retire). In a Roth IRA, your contributions have already been taxed so when you take out future earnings they are tax-free! Some argue that this does make that big of a difference because both accounts are taxed. However, if you know the right investments to choose, this can make an enormous difference. Here are the 2018 contribution limits:

image from rothira.com

image from rothira.com

3. CONDITIONS

To qualify for a Roth IRA, you must have earned income for the year, and it must not surpass that of which you have contributed. For example, you cannot make $2,000 for the year and contribute $5,000. You must have earned at least the amount you have contributed. As you can see above, there are also income restrictions. You are ineligible to contribute if you have earned over $135,000 as an individual or $199,000 as a couple. Due to the contribution limits, I urge young people to start a Roth IRA now! If you are on track to be a big earner in your career, you may not qualify to start a Roth IRA later in life.

4. CAN I TAKE MY MONEY OUT?

One of the advantages of a Roth IRA is that you can always take out the principal amount (the amount you have put in) tax-free. However, your earnings portion will be taxed, and a 10% penalty may be placed if you redeem it before you are 59 1/2. There are qualified reasons to withdrawal or redeem the funds that allow you to avoid this penalty. Full list:

  • You use the withdrawal (up to a $10,000-lifetime maximum) to pay for a first-time home purchase.

  • You use the withdrawal to pay for qualified education expenses.

  • You're at least age 59½.

  • You become disabled or pass away.

  • You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.

  • The distribution is made in substantially equal periodic payments.

5. WHere can I open a roth ira?

You can open a Roth IRA many places such as a bank, mutual fund company, or trading platform. If you open a Roth in a trading platform you have all the capabilities of a brokerage account for investments (individual stocks, bonds, ETFs, etc). If you are opening your Roth at a mutual fund company you will only be able to invest in mutual funds that company sells. If you open your Roth IRA at a bank, the same is true. If you want the most options for investments, go with a trading platform like TD Ameritrade, Schwab, or Fidelity. To compare the providers click here

So, what do you think? Having an investment account that grows tax-free is pretty cool, eh? Do you have a Roth IRA?