Roth IRA: What You Need to Know

by | Sep 10, 2019

You know that it’s important to save for your future self in retirement and you may already put money into a 401k through your employer. But did you know that there are other investment options? Today, Charlie’s going to introduce you to the Roth IRA, or individual retirement account.


What is a Roth IRA?


You may have heard that a 401k is tax-advantaged. That means you put money into it from your paycheck (automatically via payroll deduction) before Uncle Sam takes his cut (also known as pre-tax), so your taxable income gets reduced and you pay less in taxes overall. However, when you withdraw the money you saved during retirement, you’ll have to pay taxes on those funds. 


A Roth IRA works in the opposite way. You build the account with dollars paid to you after the government gets its share (or post-tax), but can take the money out in retirement tax-free. Afterall, you’ve already paid your tax bill on that cash. 


Extra reading: Although beyond the scope of this article, there are other types of IRAs. You can learn about them here and here.

Benefits of a Roth IRA


There are several benefits to having a Roth IRA:

  • Save more for your retirement: You can have this account AND your 401k.
  • Optimize your tax strategy: If you expect to pay more in taxes during retirement than you do now, it makes sense to have as many post-tax investments as possible.
  • Tap it when you need it: You can withdraw your contributions (the money you’ve put in) at any time, tax-free, and without an early withdrawal penalty. (With few exceptions, your 401k would penalize you for taking money out before age 59.5).
  • Keep your money invested longer and leave more to your heirs: You’re never forced to make withdrawals. (Other retirement savings accounts have required minimum distributions, which force you to take money out beginning at age 70.5.)


Note: While you can withdraw your contributions at any time, taking out any earnings (also known as growth) on that money is subject to a couple of rules:

  • Your Roth IRA account needs to be at least 5 years old.
  • You must be age 59.5 or older.


Not following these rules may result in a penalty. There are some exceptions, of course, and you can read about them here.

Eligibility to Save in a Roth IRA


If you’re interested in contributing to a Roth IRA, you need to meet the following requirements:

  • Earn income, usually from your job or small business revenue.
  • Have a modified adjusted gross income (MAGI) within IRS limits: Currently $122,000 if single and $193,000 if filing taxes with your spouse. 

Rules for Contributing to a Roth IRA


Before running out to open a Roth IRA, read through these important rules:

  • You can’t contribute more than you earn.
  • If your MAGI is within the above limits, you can contribute up to $6,000 per year ($7,000 if over age 50).
  • If your MAGI exceeds the above limits, you may still be able to contribute a partial amount.


To get more in-depth information about Roth IRA rules, check out this website.

How to Open a Roth IRA


You can open a Roth IRA account at a bank or brokerage firm. You may want to consult a financial advisor to assist with this process, but if you’re going the DIY-route, remember:

  • Compare the fees, customer service, reputation, and investment options offered at each potential financial institution.
  • When you apply for your account, be sure to name a beneficiary.
  • When you choose how to invest within your Roth IRA, think about how comfortable you are with risk (risk tolerance) and how long you’ll keep the money saved (investment horizon).
  • Diversify your investments to mitigate financial loss should one investment perform poorly.
  • Decide how you’ll contribute to the account — in a lump sum, with periodic deposits, automatically, manually, etc.

How to Manage Your Roth IRA


Once you have the account open, it’s important to remember that it’s not set it and forget it. You should check on your Roth IRA’s performance at least annually and make changes to your investments as needed. 


For example, if you want to hold 50% stocks and 50% bonds in your account, but market performance has left you with 65% and 35%, respectively, you’ll need to rebalance your portfolio (or collection of investments). Rebalancing entails selling off a percentage of what you’re over-invested in (in this case stocks), and using those proceeds to buy more of what you’re under-invested in (in this case bonds), so that you get back to your desired 50-50 split.


Final Thoughts


The Roth IRA can be a great retirement savings tool — but this blog post is just an overview. There are many more nuances that may apply to your specific situation. Because of this complexity, you’re encouraged to chat with a tax professional or financial planner for additional guidance.


Tell Charlie: Do you have a Roth IRA as part of your investment/retirement savings strategy?

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