How does a Roth IRA work?

A Roth Individual Retirement Account (IRA) is a type of retirement account that allows you to contribute after-tax dollars to it. Other retirement savings accounts require you to pay taxes on the funds you withdraw during retirement, not the funds you contribute while youโ€™re employed. This slight tax adjustment offers many advantages when youโ€™re planning for retirement.

After you reach 59.5 years of age, you can start withdrawing funds from your Roth IRA. Those withdrawals are tax-free because you pay taxes on your contributions, not your withdrawals. Though different account types will have nuanced rules, the most important thing is to start saving for retirement now, no matter how you do it.

How much should I put into my Roth IRA?

If you want to feel more confident about your retirement savings, you can use our Roth IRA calculator. It will tell you how much youโ€™ll have in retirement based on your current contributions. This information can help you decide if you need to make changes to your savings strategy or not.

The actual dollar amount you can add to your Roth IRA each year is limited. For the 2022 tax year, you can only contribute up to $6,000 if you are under 50 years old. If you are 50 years of age or older, you can contribute $7,000 annually. Due to these restrictions, if you can max out your contributions annually, thatโ€™s the best-case scenario.

Which is better: a 401(k) or a Roth IRA?

Traditional 401(k)s and Roth IRAs are both fantastic ways to save for retirement. Many people will put money away in both of these accounts simultaneously to take advantage of the benefits that come with each one.

With a traditional 401(k), your contributions are tax-free. This gives you larger sums of money to invest and grow over time. Then, when you are retired, you will pay taxes on the amount you withdraw each month.

Roth IRAs are different. Instead of the funds being taxed when you withdraw them, you get taxed on your contributions. Since you are likely in a lower tax bracket when youโ€™re younger, paying taxes on the funds now will mean that you wonโ€™t pay taxes on them later in life, when youโ€™re in a higher tax bracket.

How much will my Roth IRA grow in 10 years?

The growth of your Roth IRA will depend on how much you contribute each year, what your investment portfolio looks like, and how the markets do that year. On average, Roth IRAs see returns of 7% to 10% annually.

These returns then compound year over year, increasing the amount that you can invest. This will make your returns even higher next year.

Even if you stop contributing money within the 10-year period, your Roth IRA will continue to grow.

What are the downsides of a Roth IRA?

Roth IRAs alone will probably not generate enough funds for you to live comfortably in retirement. Unlike traditional 401(k)s, these accounts have very low contribution limits, which is one of their biggest downsides.

Another downside of a Roth IRA is that its tax policies become less favorable if you are already in a high tax bracket. One of the major benefits of a Roth IRA is that when you pay taxes on your contributions, it is likely that youโ€™re in a lower tax bracket than you will be when you withdraw the funds later in life, thus, saving money.

The last major downside of a Roth IRA has to do with convenience. Your contributions to a 401(k) are deducted directly during the payroll process that your employer owns, so you donโ€™t have to do anything for these deductions to happen. With a Roth IRA, automatic payroll deductions are not common, forcing you to manage your contributions with a more hands-on approach.

What is the five-year rule?

The five-year rule does not allow you to withdraw any money from your Roth IRA unless it has been at least 5 years since you first contributed to the account. This rule has no exceptions; even if you are 110 years old, you cannot withdraw any funds until your Roth IRA has been active for 5 years.