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Your Guide to the Roth IRA, Part 2

Fast track your retirement savings with this tax-advantaged account.

By
Laura Adams, MBA
5-minute read
Episode #273

2.  When you’re young. If you’re just starting your career, not only is your income generally low, but you have decades to go before retirement. If your Roth IRA account value explodes over time, you’ll avoid paying tax on a heap of money.  

For example, if you invested $400 a month for 40 years, that’s a total of $192,000 that you put away in your Roth IRA ($400 x 12 x 40 = $192,000). If you earned an average return of 7%, your account would be worth over $1 million dollars after 4 decades.

The difference between the account value and your contributions is massive—over $800,000 ($1 million - $192,000 = $808,000). And every penny of those investment gains would be exempt from tax because it’s in a Roth. If your average tax rate were 15%, that’s a tax savings of over $120,000 ($808,000 x 0.15 = $121,200)!

3.  When you don’t need a tax deduction. The best part about a traditional IRA is getting a tax deduction in the current year. That can be a godsend when you don’t have any other tax deductions or credits to shrink a big tax bill.

But if you already have plenty of ways to trim your taxes—like mortgage interest, medical expenses, or tax credits—then making Roth IRA contributions would be an advantage. 

4.  When you participate in a retirement plan at work. If you (or your spouse) make contributions to a workplace retirement account—like a 401(k) or a 403(b)—and you earn over a certain amount, some of all of your traditional IRA contributions may not be tax deductible. 

Related Content: Should You Contribute to Both a 401(k) and an IRA?

With a Roth IRA, on the other hand, there’s no limitation to maxing it out and contributing to a retirement plan at work in the same year.

Quick and dirty tip: If your employer offers to match contributions you make to a workplace retirement account, always contribute enough to max out the match before contributing to an IRA—otherwise you’re leaving money on the table.

5.  When you want the option to withdraw funds before retirement. Since you pay tax upfront on Roth IRA contributions, you can withdraw them at any time without paying additional tax or penalties. That means you could easily use the money any way you like, such as to buy a home, pay for education, or start a business.

Of course, I don’t recommend withdrawing funds from a retirement account unless you already have a healthy nest egg somewhere else. And as you learned in part one, withdrawing earnings from a Roth IRA before the official retirement age of 59½ generally triggers income tax and a 10% early withdrawal penalty.

Best Investments to Own in a Roth IRA

Since the Roth offers tax-free account growth, you’ll get the most tax savings by owning investments that could potentially mushroom in value, such as growth stocks and funds.

Other smart choices are investments that pay dividends, like bonds, bond income funds, and dividend stocks. All of the investment growth and income that you hold in a Roth IRA will be tax-free when you decide to take withdrawals in retirement.

Related Content: How to Retire Early and in Style—Without a Fortune!

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About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.