A Roth IRA (Individual Retirement Account), is an investment retirement account that allows you to invest and withdraw gains from your investment account tax-free. That means all of the money you make from your investments go straight to you and none go to the government.
If you are unfamiliar with how taxes work with investments, click here to learn more.
A Roth IRA is a powerful tool that can be used to maximize your financial future. However, there are a few requirements you have to meet to even qualify for contributing to a Roth IRA.
Roth IRA Qualifications:
You can only contribute to a Roth IRA if you make below a certain amount (See below for 2021 income qualifications)
Only the income you earn can be contributed to a Roth IRA
2021 Roth IRA Income Qualifications:
Maximum Contribution for individuals under age 50 | Maximum Contribution for individuals age 50 and older | Single Filers Income (MAGI) | Married Filing Jointly Income (MAGI) | Married Filing Separately (MAGI) |
$6,000 | $7,000 | under $125,000 | under $198,000 | $0 |
$5,400 | $6,300 | $126,000 | $199,000 | $1,000 |
$4,800 | $5,600 | $128,00 | $200,000 | $2,000 |
$4,200 | $4,900 | $129,500 | $201,000 | $3,000 |
$3,600 | $4,200 | $131,000 | $202,000 | $4,000 |
$3,000 | $3,500 | $132,500 | $203,000 | $5,000 |
$2,400 | $2,800 | $134,000 | $204,000 | $6,000 |
$1,800 | $2,100 | $135,500 | $205,000 | $7,000 |
$1,200 | $2,100 | $137,000 | $206,000 | $8,000 |
$600 | $700 | $138,500 | $207,000 | $9,000 |
$0 | $0 | $140,000 & over | $208,000 & over | $10,000 & over |
To simply put it, if you are single and make $140,000 or more annually, then you cannot contribute to a 401k. If you are married and make a total combined income of $208,000 or over, then you cannot contribute.
However, if you qualify for a Roth IRA based on the criteria above, the contributions that you make must be income that has already been taxed. Taxed money in, tax-free gains out.
Now that you know about the requirements for opening a Roth IRA, let's talk about the rules when it comes to using a Roth IRA:
Roth IRA Rules
As of 2021, the maximum contribution is $6,000 annually. If you are age 50 or over, it is $7,000 annually.
At any time, and for any reason, you can withdraw your contributions tax-free.
You can withdraw your gains from your investments tax-free once you become age 59 ½
You are allowed to withdraw earnings from a Roth IRA before the age 59 ½ , but it may cause taxes and penalties depending on the situation.
Due to COVID-19, the new CARES Act states, if you have been affected by COVID-19, you can withdraw as much as $100,000 from a Roth or traditional IRA without paying a penalty for being under 59½
So, why do you need to get a Roth IRA immediately if you don’t already have one? The answer has to do with one of the rules mentioned above;
“..as of 2021, the maximum contribution is $6,000 annually. If you are 50 or over, it is $7,000 annually.”
Because of compound interest the earlier you start investing, the more money you earn over time based off historical trends. Take a look at the infographic created by BedelFinancial:
Assuming that your money grows at an average of 7% every year, the difference between investing $6,000 a year at age 25 compared to age 35 until you are 65 is $355,211! If you started investing at age 25, you would have invested $240,000 over the course of 40 years ( (65 years - 25 years) * $6,000). Meaning, you would have gained $482,485 on your investment. However, if this was done in a normally taxed investment account, after withdrawing your investment gains from the account, you would owe the government around $150,000 in taxes. On the other hand, in a Roth IRA, if you withdraw your investment gains at age 65, you would owe the government, you guessed it, 0$ dollars in taxes - leaving you with a total of $722,485 to take home.
The earlier you start a Roth IRA, the better. If used correctly, the combination of compound interest and 0% taxes on your gains can be a powerful tool to maximize your financial future and definitely set you up for a successful retirement.
How do you get started with a Roth IRA?
You know the requirements and rules of a Roth IRA, and you also know why it can be such a powerful financial tool. The next question is, how can you start a Roth IRA? The good news is there are a number of sources that offer Roth IRA accounts. Vanguard, Betterment and Forex are a few examples. It is also possible that your bank could offer Roth IRA accounts. A simple Google search for a "Open a Roth IRA" will bring up plenty of resources that would provide resources.