This article will show you how to invest in the Roth IRA and why you should highly consider using it. For many people, the Roth IRA may be your second most important investment. You may have already started the first, but if not, I will show you where to get that information too. If you’re not familiar with the benefits of the Roth IRA, read on.
First, three major benefits of the Roth IRA, then I will get into some of the nitty‐gritty details.
1) Money is hard to get
That probably doesn’t sound like a benefit, but it’s one of the greatest benefits of the Roth IRA, along with other qualified retirement plans like the 401k. Effectively managing your money is more about controlling your behavior than anything else. The more automated features built into your finances that are beyond your control, the more success you’ll have.
The IRS penalizes you heavily for early withdrawals, thus you’re less likely to withdraw the money for unnecessary luxuries. It also takes time to get to the money so most of your impulse purchases seem to fade in importance after a few days. This alone can protect your retirement nest egg.
The money is very hard for creditors to get to. That may not seem important now, but, it could be the difference between wealth and poverty. With rampant law suits, unemployment, debt, bankruptcy, and the possibility of a serious at fault auto accident, your money is almost bullet proof in the Roth IRA. You may never need this protection, but if you do, you can’t wait until it’s too late.
2) Tax Free
Here’s the big one. Any money you invest in your Roth IRA, and any investment growth inside the account, is tax free when you withdraw it after retirement. It’s impossible to predict the future, but with the direction of the U.S. government, it’s probable that taxes will be higher in the future. It’s impossible to predict, but even if that’s not the case, paying no taxes in retirement is not only financially sound; it will give you peace of mind too.
3) Larger investment
The Roth IRA contribution limit in 2012 is $5,000, or $6,000 if you are over the age of 50, but they change all the time. They both have the same annual limits, but in a way, you can invest more money in a Roth IRA than in a traditional IRA.
The limits are the same, but the difference between the two is that you would have already paid taxes on the $5,000 going into the Roth IRA. Effectively more money is going to work in the Roth IRA than the traditional IRA because of the difference in taxes when you withdraw it. The math is complicated, but just trust me. Because of the effect of taxes, more money goes to work immediately in the Roth IRA than the traditional IRA.
What is a Roth IRA?
The Roth IRA is an account established by U.S. law, where you can hold many different types of investments. Within the Roth IRA account, you can invest in things such as cash, certificates of deposits (CDs), stocks, bonds, mutual funds, real estate, etc.
The same investments that you can buy outside of a retirement account can also be purchased within the Roth IRA account. The Roth IRA simply applies rules that protect your money and imposes tax laws (usually beneficial) to you and the investment.
For example, you can go to your local bank and buy a certificate of deposit (CD). You can also buy that same CD within a Roth IRA, but different rules apply regarding how it’s taxed and when and how you can withdraw that money.
Roth IRA vs. IRA
The primary difference between an IRA and a Roth IRA is when you will pay taxes on the money. When you invest in an IRA, you get an immediate tax deduction, but you will pay the taxes when you withdraw the money in retirement.
However, with the Roth IRA you do not get an immediate tax deduction, but when you withdraw the money in retirement, you pay zero in taxes. You also pay zero taxes on your investment gains. There are other differences, but those are the major ones.
There are many other investment options, and you should review them all with the help of a financial professional. It’s particularly important to consider your employer’s 401k plan, especially if they match a percentage of your investment.
Roth IRA Movement
This brief introduction into the Roth IRA was inspired by my friend Jeff Rose who started the ‘Roth IRA movement’ to educate and spread the benefits of this great investment tool. This is much bigger that you and I.
His inspiration for this began after speaking to a group of 50 college seniors. Not a single one had ever heard of the Roth IRA. I agree with Jeff, it’s disturbing that kids can go through 17 years of school and never once be exposed to one of the most important tools for financial freedom and living life on your own terms.
This led Jeff to set up the ‘Roth IRA movement,’ which will include over 135 bloggers who will be sharing a similar message on March 27th 2012. It’s a fantastic idea that will hopefully help as many people as possible.
Many people have used a reverse mortgage to access your home’s equity for retirement funds. This is sometimes called a reverse loan or a home equity conversion loan. There are pros and cons to using this method for retirement funds, so be sure to seek the advise of an expert.