What Firefighters Need to Know About Roth IRAs
Your options for retirement savings can get confusing pretty quickly. What is a 401(k), 457(b), 403(b), or IRA anyway? Are the contributions Roth or not, and what does that mean? Is it tax-free or tax-deferred? It is no wonder folks put off retirement investing. It makes you feel like you probably should have learned this stuff in school.
In our what you need to know series, we are going to explain, over time, all the options you may have at your disposal to build wealth for your golden years.
Today’s Topic is the Roth IRA.
The IRA is an Individual Retirement Arrangement. This arrangement has to do with how the account is treated under the law. The arrangement allows for special tax treatment depending on whether the account is a traditional or a Roth IRA.
Often you’ll hear talking heads praise the tax-free nature of the Roth IRA. In actuality, it is not completely tax-free. The money that you put into a Roth IRA is after-tax money. Meaning, you have already paid income taxes on that money. Now your free to do whatever you want with it. Including investing it in a Roth IRA.
A Roth IRA is an account that provides favorable tax treatment on the growth of your investments. It isn't actually an investment in and of itself. Once you open the account, you must transfer your money into it (automate if you can) and then decide how you want to invest it. Your options can seem endless so seek advice for investment help if you are not comfortable doing it on your own. (That’s what Forward Focus Financial Planning is here for).
The tax-free portion of the Roth IRA comes into play when you talk about the growth. And that is where it gets very interesting.
Tax-Free Growth...I like the sounds of that.
Let's say you contributed the current limit to your Roth IRA every year for 30 years. That means you contributed $6,000 dollars (the current maximum contribution limit for 2019) to your IRA yearly. Which only equates to about 16 dollars a day.
At the end of that 30 years, you would have contributed $180,000 of your hard-earned after-tax money. But, at an 8% rate of return, your investment would have grown to a little over $720,000. That is $540,000 of tax-free money. You will not find a better deal than that.
That is a game-changer. At 10% it is over a million dollars. Talk about a nest egg. And you will not have to pay a cent of it towards income taxes nor take required minimum distributions.
Are You Eligible?
Unfortunately, there some limitations around who can utilize a Roth IRA. If you earn too much, you cannot contribute directly to a Roth IRA. There are ways around this, but we will save that for another day. Contribution phase-outs start at $193,000 if you are married and at $122,000 if you are single. If your income falls below these thresholds, you are allowed to contribute up to the maximum contribution limit.
The Roth IRA can be an excellent tool for building wealth and preparing for retirement. If you are a do-it-yourselfer, you can open one and begin contributing at any online broker (TD Ameritrade, Schwab, Vanguard, etc) or one of the Robo-advisors (Wealthfront, Betterment). If the thought of doing that overwhelms you and you'd like some guidance—find a qualified financial planner through XYPN or NAPFA.
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