The How and Why of Opening a Roth IRA
This post is from PT of ptmoney.com, author of 52 Ways to Make Extra Money.
The Roth Individual Retirement Arrangement (IRA) is a retirement savings account created by the US federal government, regulated by the IRS, with the intention of creating a tax incentive for you to save more for retirement. It was created years after the traditional IRA to please those looking to shelter future income from taxes vs current income. Here’s how it works: you open up a Roth IRA, start contributing after-tax funds, choose your investments, retire, and withdraw your Roth IRA funds tax free. That’s right. You get to withdraw your money in retirement without paying taxes. If you expect to save enough to retire on, then your account will see significant gains (earnings) over the long haul. And in a normal taxable account, you’d pay upwards of 35% in taxes for those earnings. With the Roth IRA you don’t have to pay those taxes. Nice.
Contributions to the Roth IRA are limited to $5,000 annually ($6,000 if you are older than 49). Withdrawals from your Roth IRA earnings can be made tax and penalty free at the age of 59 and a half. Keep in mind that there are income limits to those who qualify to use a Roth IRA.
Most people use a Roth IRA in combination with their 401K or company pension. Why? Well, because it has an opposite tax treatment, and thus, will give you tax diversification in retirement (i.e. pay taxes on some savings now, pay some later).
So how do you open up a Roth IRA? Well, it’s pretty easy these days. You can go to a bank, a mutual fund company, or you can pick from one of the best online stock brokers. If you’re looking to do mainly passive investing within your Roth IRA, then I suggest a mutual fund company like Vanguard. If you are going to be more of an active trader wanting to do cheap stock trading, then choose a low-cost online broker. Skip the banks, as they may be expensive and have a limited choice of funds.
Once you have your account opened, you will need to choose some investments. You can usually invest in a variety of investment types within your IRA: individual stocks, bonds, funds (index, mutual, EFTs), and more. Find an asset allocation model that fits your age and risk tolerance and choose the investments that will give you that mix.
Now that you have an account and some investments picked out, create automatic savings contributions to the account. It’s critical that you set up automatic contributions. Since this account is not tied to your employer, it’s up to you to remember to save. Creating an automatic savings plan will help to take the pressure off of trying to remember. Start small and work your way up to contributions that will get you to your annual limit of $5,000.
Have you considered a Roth IRA? What’s stopping you from opening one up today?
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