Saving for retirement can seem like a pretty daunting task. There are many variables to consider and a virtual alphabet soup of retirement plans. So, let’s cut through the clutter. All you need to get started is a little knowledge of those retirement plans and how to use them. That’s why this month’s blog posts are a series on fundamental ways to save for the future while lowering your tax bill.

This week let’s talk about Roth IRAs. We’ll cover what they are, their benefits, their potential drawbacks, and how to open one.

Let’s go!

What is a Roth IRA?

A Roth Individual Retirement Account is a retirement saving vehicle allowing you to invest in individual stocks, ETFs, and mutual funds while lowering your tax bill. Contributing to a Roth IRA won’t lower your tax bill immediately. The money you put in from your earned income is taxed at its normal rate. The tax break comes when you withdraw the money after 59 ½. That money can be withdrawn entirely tax-free.

But that isn’t the only benefit.

The flexibility of a Roth IRA

With a Roth IRA, your money grows tax-free, as well. So, the money can potentially compound faster. And when you do retire, there are no required distributions.

Traditional IRAs require you to withdraw a certain amount from your account after age 72 whether you want to or not. That means the money stops growing and compounding. Roth IRAs let you hold the money as long as you like, even passing it down to your heirs.

It can also act as a sort of emergency fund. You can withdraw contributions without a penalty if the money has been in the account for five years or more. A word of caution, you can’t withdraw any earnings on that income unless you are willing to pay a penalty tax. For example, you invested $5,000 in your Roth IRA 10 years ago. That money has compounded and is now worth $6,500. You can still only withdraw $5,000 of that before a 10% penalty on the entire distribution kicks in.

Of course, it’s best not to touch retirement savings unless you absolutely must. However, in a real emergency, it can still be a resource.

So, Roth IRAs have flexibility, but it isn’t all sunshine and roses.

Potential downsides of a Roth IRA

One potential negative is one mentioned earlier. You don’t get any tax breaks today on earned income in a Roth IRA. So, if you want Uncle Sam’s hand out of your pocket on the next paycheck, Roth IRAs may not be your best bet.

And if you earn too much, you can’t contribute to a Roth IRA. Single filers earning more than $153,000 in 2023 are out of luck. So are married couples filing jointly if they earn more than $228,000.

If none of those situations give you heartburn, then it may be time to set one up.

Here’s how.

Opening a Roth IRA

You can open a Roth IRA with any institution the IRS has approved. Potential resources include brokerage firms, banks, some credit unions, and savings and loan associations. However, many people go through a brokerage because they tend to have more investment options, and fees are usually lower.

Also, opening an online brokerage account is pretty simple. You can be up and running in about 30 minutes. Once you open the brokerage account, you can choose from various investments such as mutual funds, exchange-traded funds (ETFs), stocks, bonds, and money market funds. Mutual funds and ETFs that track broad indexes like the S&P 500 are popular because of their history of generating high returns.

However, it is best to speak with an investment professional about your goals and do additional research to determine what is right for you.

The Bottom Line

Roth IRAs are a flexible way to invest for the future and enjoy tax benefits. And though they may not be for everyone, learning more about them is worth your time.

Next week, we’ll compare Roth to traditional IRAs so you can learn more about retirement options. See you then!