What is a Roth IRA & Why Should I Have One?
If you live in the US, chances are, you will have to save money to fund your own retirement. In an ideal world, societal infrastructure would provide for the elderly, and saving for retirement wouldn’t be necessary. Unfortunately, the world is not at all ideal. A Roth IRA is a type of account that you can use to save for retirement, with some advantages. If you’re a young person, and early in your career, this is a great tool for you to add to your portfolio for your future self.
Okay, so what is a Roth IRA?
A Roth IRA is an investment vehicle (think of it like a basket), that allows you to put after-tax money away for a retirement. When you withdraw that money at age 59.5 or older, it’s not taxed as income.
How does it work?
So the Roth IRA, as I said, is a basket, where you put investments to grow until you retire. The investments could be basically anything: stocks, bonds, ETFs, mutual funds, etc, just like any other type of investment account. Unlike a 401K or 403b (those are the retirement plans that you get through work, if you even have them) the money you put in (contributions) is after-tax money which means that when you withdraw money as a retiree, you don’t have to pay taxes on it.
What are the downsides?
- You can only put after-tax money into it, so you can’t deduct contributions on your taxes.
- The amount you can contribute per year is pretty low (in 2023, it’s $6500)
- You still have to choose the investments in the account (or pay someone else to do it)
- There’s an income cap to eligibility, so if you make more than a certain amount, you can’t contribute anymore.
So why do it?
- As a young(ish) person, your income and tax rate are likely to increase as you’re older, so this may be a very cheap way to save for retirement, since there are no taxes on that money later.
- Remember how I called it a basket? Having a Roth IRA is another basket to put your retirement eggs in, so you’re not just relying on a 401K/403B/etc., or Social Security.
- Unlike your workplace retirement account, you can pick whatever investments you’d like to have in your Roth IRA.
- There are qualified withdrawals that you can take, outside of retirement income, such as in times of financial hardship (that’s new!) or when you need money for a down payment on a home.
Another thing to consider here is that because the contribution limit is pretty low, maxing out your Roth IRA can feel more attainable than maxing out your workplace retirement account, so it might be a good psychological tactic to help you save more.
When I was in my twenties, I used side hustle money to open and put a bit of money in a Roth IRA. This also helped me learn to invest without the tax implications of capital gains, etc. (which I would have had with a brokerage account), and gave me a lot of confidence in figuring out how to handle my own finances, so Roth IRAs have a special place in my heart.
