When considering how much money you need to retire, your goal is likely in the millions. Being a millionaire at retirement is an excellent start to comfortably living off the interest on your retirement account. With a Roth IRA, you can leverage your retirement savings to reach the millions well before retirement.
Of course, attaining this goal takes strategy, careful planning, and consistency. The earlier you can start putting away savings in a Roth IRA, the longer your money can grow into the millions.
- A Roth IRA allows you to pay income taxes on contributions at the start, then grow that amount tax-free.
- Roth IRAs can either be traditional, which involves classic financial investments, or self-directed, which involves nontraditional investments.
- Backdoor strategies can help you increase the size of your Roth IRA beyond the maximum yearly contributions.
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What Is a Roth IRA?
A Roth IRA is one of the primary retirement accounts to grow your savings consistently. It’s an individual retirement account (IRA) that holds after-tax contributions, allowing you to make tax-free withdrawals in the future. You don’t have to pay income tax on any interest the account earns over time. You can contribute up to $6,500 per year of post-tax money into a Roth IRA, which means you won’t ever pay taxes on this money or any of its gains.
Roth IRAs are unique from traditional IRAs, allowing you to take a deduction now and pay income tax at withdrawal time. Because traditional IRAs earn interest on a pre-tax amount, you also have to pay taxes on any interest at the time of withdrawal. This feature makes Roth IRAs especially appealing for people seeking to maximize the growth of their retirement accounts.
Roth IRA Withdrawals
Because the money you deposit into a Roth IRA is already taxed, you can withdraw your initial contribution anytime without a tax penalty. However, making withdrawals less than five years from the initial deposit can have penalties for any earnings on your contributions or any amount you converted from another account. If you’re 59 1/2 or older, you can withdraw penalty-free without letting your funds mature for five years.
Roth IRA Example
Imagine that you contribute $6,500 in the first year after paying taxes on your earnings. If you eventually earn $650 in interest after letting the funds mature for at least five years, you can withdraw the total $7,150 tax-free. This scenario ultimately means you can avoid paying income tax on the $650 interest. If you contributed the same $6,500 to a traditional IRA and earned that same $650, you would have to pay taxes on the total amount upon withdrawal, including the interest.
How to Use an IRA to Grow Your Wealth
A Roth IRA can help you start working toward your first million in retirement savings. Follow these basic steps to get started:
1. Consider a Self-Directed IRA
A standard IRA lets you invest in common investments, such as stocks and bonds. This IRA type can be a reliable, steady way to grow your income while only taking on limited risk. However, opening a self-directed IRA (SDIRA) allows you to maximize your account’s growth. SDIRAs will enable you to invest in atypical assets, including cryptocurrency, real estate, gold, and privately-held companies. By giving you more control over your investments, SDIRAs can grow beyond the average returns you get from the stock market.
Self-directed Roth IRAs have the same tax advantages as a classic Roth IRA, meaning that once you pay taxes on the initial contribution, you won’t owe taxes on withdrawals or dividends. A knowledgeable advisor can help you maximize your contribution with well-selected assets in an SDIRA. Despite the benefits of an SDIRA, traditional Roth IRAs may be easier to manage for new investors. Considering which option is best for your desired level of involvement and investment goals before opening an account is essential.
2. Open an Account
Brokerage firms and banks typically offer Roth IRA services, among other retirement account options. Compare the account minimums, management fees, and additional charges associated with IRAs from different providers. Once you select a broker, you can set an appointment to open your account.
Not all brokers offer self-directed Roth IRAs, so you may need to look for a specialized advisor to be your account’s custodian if you want to pursue this option. Research what types of investments your potential SDIRA advisor can help you manage before you start your application. Some custodians may not work with specific investments, so clearly define what types of assets interest you before opening an SDIRA.
3. Convert Other Retirement Accounts
You can transfer funds into your Roth IRA with an existing retirement account. It’s easier to grow a retirement account into the millions when you have a significant initial investment, so this is a great way to get your Roth IRA off to a strong start. Because Roth IRAs have yearly contribution limits, converting an existing account is one of the easiest ways to increase the size of your investment.
When you roll over a 401(k) or a traditional IRA into a Roth IRA account, you pay income taxes on the lump sum you want to convert. Paying taxes in the short term means you won’t have to pay taxes on that amount or any future earnings when you withdraw. You can enjoy tax-free dividends and compounding growth of that amount for the life of the account.
4. Contribute the Maximum
The more you contribute to your retirement account, the faster it can reach a million dollars. People making regular, small contributions to a Roth IRA starting in their 20s or 30s can use the compounding interest to grow a much more significant investment than those who contributed a higher lump sum in their 50s or 60s. You can enjoy higher and higher returns by submitting the maximum contribution each year.
Currently, the maximum is $6,500 per year. For individuals ages 50 or older, you can contribute the “catch-up” amount of $7,500. Prioritize these contributions as part of your regular budget to consistently build your retirement account.
5. Use Backdoor Strategies
Although Roth IRAs have contribution limits and income limits, you can employ strategies to invest tens of thousands of dollars more into your Roth IRA every year. For example, many high-income individuals use the backdoor method, which involves repeatedly making non-tax-deductible payments to a traditional IRA and then converting the account to a Roth IRA. If you have a 401(k), you can also convert these contributions into a Roth IRA. This approach is a mega backdoor because 401(k)s have much higher contribution limits. Even when you deduct pre-tax contributions from your 401(k), this is still a generous $43,500.
Managing backdoor accounts involves being aware of tax regulations and understanding how to oversee and transfer multiple retirement accounts. When attempting these strategies, it’s a good idea to have support from an experienced advisor who can help you execute them successfully.
6. Let Your Roth IRA Grow
The most important thing you can do to grow a million-dollar IRA is to give it time to develop. The longer money sits in your account, the more time your investments have to earn dividends and create compounding interest. Even though you can withdraw money from a Roth IRA early without significant penalties, it’s best to wait until retirement or beyond to withdraw your funds.
7. Set Up a Custodial Roth IRA for Your Family
If you have children, you can use Roth IRAs to help build generational wealth. A custodial Roth IRA allows minors to invest their income from summer jobs, babysitting, and more. If you’re a business owner and your children help with your business part time, consider putting them on your payroll. Your children can invest their paycheck completely tax-free into their custodial Roth IRA if they make less than a certain amount. This strategy can help you build generational wealth for your family and give your children the best chance at growing a healthy, multi-million-dollar retirement account.
Roth IRA Wrap-Up
Whether setting up your first retirement account or looking for better ways to manage your current retirement fund, a Roth IRA is worth considering. When used correctly, this tool can help you maximize earnings from interest and turn regular after-tax contributions into a lucrative investment. The best time to start an investment account is now, so schedule a consultation with Anderson Advisors today. Our trusted team of experts can guide you through your options to set up a Roth IRA to serve you for life.
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