This week I’m continuing to share some thoughts about retirement accounts. Last month I wrote about 401(k)s which are great if you are at a corporate job, but might not be available to freelancers or part-time workers.
At the beginning of each calendar year I review new limits and rules to plan for my goals. Let’s keep talking about Individual Retirement Accounts (IRAs) - specifically Roth IRAs.
Roth accounts are relatively new and were part of the Taxpayer Relief Act of 1997. Roth IRAs were offered in 1998 as another way for Americans to save for retirement.
Remember, retirement accounts have tax benefits that regular investment accounts do not. Most commonly you don’t pay taxes on the contributions you put into a retirement account and only need to pay taxes when you withdraw your money in retirement. The Roth account is the exact opposite of this. You pay taxes first, then put after-tax dollars into your Roth IRA, and your money grows tax-free. You don’t pay taxes in retirement as long as you play by the rules.
Let’s review a few core questions and then we’ll get to 4 considerations about Roth IRAs:
How much can I contribute annually? In 2023, up to $6,500 if you are under 50 & up to $7,500 if you are over 50. In 2022, up to $6,000 if you are under 50 up to $7,000 if you are over 50.
Is there a contribution age restriction? No!
When can I take money out without penalties? After holding the account for 5 years and being at least 59 1/2 years old.
Does this account have mandatory distributions (aka the tax man forces you to start withdrawing money at a certain age)? No! This is a great benefit to the Roth IRA that differs from a Traditional IRA. It also makes this a great generational wealth builder to pass on to heirs.
Below are 4 areas I would consider before contributing to a Roth IRA:
1. Review your annual income - do you qualify?
Roth IRAs are a great retirement tool for the average earner. If you are lucky enough to make more than $138,000 MAGI annually you start to get phased out of the ability to fully contribute to a Roth IRA.
Wait - what’s MAGI? Another fancy acronym (oy!) that means Modified Adjusted Gross Income. MAGI is your adjusted gross income for the year with certain tax deductions added back. It’s easy to calculate around tax time and I recommend confirming with an accountant or your tax software what your MAGI is and if it falls within the Roth IRA limits.
I recommend checking out Schwab’s phase-out chart here.
2. Can you afford to contribute? Review your budget and see how this fits
Unlike a 401(k) a Roth IRA is not tied to your employment, that said you need to contribute earned income. Earned income can include many things such as wages, salaries, bonuses, self-employment income, money related to divorce such as alimony & child support.
Back in college I worked at various part-time jobs. I was making minimum wage and when my Dad realized I was saving money he encouraged me to open a Roth IRA. I was only 20 years old and started saving small amounts for retirement. This made the Roth IRA my favorite investing tool and thank you to my Dad who encouraged me to make good financial decisions early on!
Lastly, $6,500 is a lot to save annually and I recommend fitting this into your budget so you can plan ahead to contribute. It’s ~$542 every month for 12 months. Remember, even if you cannot contribute the full $6,500, could you contribute $2,000 which is ~$167 per month for 12 months? Don’t feel ashamed or pressured to contribute everything, small steps towards retirement will also make a difference - your 59 1/2 year old self will thank you!
3. Open or contribute to an account
I have my Roth IRA account open at Charles Schwab. I have had a positive experience with the account, plus they have $0 monthly service fees and a $0 account minimum. I always look for no fee accounts, why spend money to have an account when you could have one for free?
If you haven’t already opened an account or contributed to a Roth IRA for 2022, don’t worry, you still can through tax day 2023! Last year’s limit was $6,000. You can also start contributing in 2023 from January 1, 2023 through tax day 2024.
4. Track your growth
Every quarter - or sometimes monthly I sit down and log into my Schwab account to see the investment growth and make sure my money is invested rather than sitting in cash. I will admit, I do this more often when the market is doing well and less often when it’s doing poorly.
I recommend checking every 3-6 months depending on how it makes you feel. Checking in on growth makes me feel better about the money I’m withholding from myself today to set up my future self for retirement.
There you have it - 4 considerations towards preparing you for retirement with your Roth IRA.
Learn more about my other favorite retirement account, the HSA (Health Savings Account), in the next few weeks!
Follow me @pointsforchange on Instagram for more posts and content coming soon.
Disclaimer: I am not a financial advisor. My suggestions are simply suggestions and not financial advice. You should always consider your personal financial situation and what works best for you prior to making financial decisions because personal finance is… well… personal.
