With the millennial generation coming of age we are in dire need of a basic financial literacy to help navigate the waters of this post recession world. Most know how to get a check and know how to spend it, but how many know how take part of that check put it in an account, hopefully increase the value of that investment, and when it is ready take it out and spend it without even needing to pay the taxes?
If you do know then congratulations, you are probably well on your way to financial freedom and an early retirement. If not, then continue reading on what Roth IRA is, what it does, and how you can gain early financial independence by having one.
1) What is it and Why do I need it?
Alright first things first, what is a Roth IRA? a Roth IRA is a personally held retirement plan that by US law, cannot be taxed if certain requirements of the plans met. Similar to a pension you may get at work such as a 401k, the difference being that instead of your plan being managed by your company, a Roth IRA is entirely ran by you. And in doing so, the ability to buy bonds, stocks, commodities, mutual funds, and even real estate inside of your Roth IRA account.
Now another reminder to the new and inexperienced investors reading this article is that a Roth IRA or any other retirement investment plan is not an investment in itself. A retirement account is a TAX SHELTER on the investments made inside of the account that each have their own rules and tax codes that they must follow. This article will be talking about the rules of a Roth IRA, if you are wanting information on different plans such as a traditional IRA, 401k, or Roth 401k, I suggest looking for a different article as there are many good sources of information on each of those plans elsewhere on the web.
As stated before in the paragraph above a Roth IRA is a self ran retirement investment account that once you reach the age of 59 ½ and the money has at least 5 years of maturity you may begin taking out without paying any taxes such as an income tax or capital gains. That money is all yours to do with what you please without having to give Uncle Sam a piece of the pie. Some of the rules, requirements, and limitations of having an Roth IRA are later in this article.
2) How do I get one?
Opening a Roth IRA if incredibly easy. Most banks, investment banks and credit unions are capable to allow you to walk, call, or email them and get you set up with one on that day. Other methods of opening a Roth IRA involves using one of the many online brokerage companies such as Scottdale allow you to open one within your own brokerage account.
These are the main requirements that apply to acquiring, contributing, and getting the distribution out of your investment into a Roth IRA:
.Any person must pay income tax to set up and fund a Roth IRA
.Single filing must make less than $123,000 income to give to a Roth IRA
.Joint filing (Married or Widow(er)) bus have a joint income of less than $188,000
.If under the age of 50 a person may offer $5500 per year to their Roth IRA
.Those over the age of 50 may give $6500 per year
.Account requires at least 5 years old and an age of 59 ½ for penalty free distribution
There’s a few small adjustments that must also be taken into account like sources of income, house buying, and certain tax filings, but these topics are better discussed individually with your accountant and not an online article.
4) Risk & Reward Management
My favorite and most valid reason for opening a Roth IRA is the notion that you get to control the investments yourself. While this is scary to many people as they fear they will lose their entire retirement, the risk is really what you make of it. Keeping the risk low by putting your money in established mutual funds or exchange traded funds(ETF’s) has always given a positive return of investment over the long run. Or you can use your retirement account as a learning opportunity on the art of investing.
Reading up on books such as The Intelligent Investor by Ben Graham, and Beat the Street by Peter Lynch are a great way to learn the fundamentals of proper investing for the beginner and hopefully leading to higher returns in doing so.
5) Number Crunching
Let’s take a basic example of someone who opens up a Roth IRA at the age of 25, and puts in the largest amount of money they can per year ($5500) into the S&P index fund . The average year-over-year return of the S&P index fund (which is equal of 1/10 or 10% of the price of the entire S&P) is around 7%.
If this person continues adding $5500 a year investing it into the S&P ETF at the age of 60 that person would accumulate roughly $2,569,398.86 (unadjusted for inflation) in tax-free income. Income can differentiate both ways dependent on how you invest. But taking a safe one of the safest investment routes possible while being consistent in adding the most income. Being smart and paying yourself now with a Roth IRA you will reap the rewards and benefits later.
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