I strongly believe that if you only make one investment in your lifetime, it should
be a Roth IRA. And this is because if you simply invest the yearly contribution to this account,
you are almost guaranteed to be a millionaire by the time you retire. Unfortunately,
according to the investment company institute, only 20% of Americans are taking advantage of this
investment account. Whether it’s because it seems complicated or most people simply don’t know about
the benefits, we’re going to fix that today. In this video, I’m giving you a complete overview of
Roth IRA investing. I’m going to show you why this is perhaps the best way to invest for retirement,
and how it can earn you millions over your lifetime. Then I’ll dive into some of the
rules surrounding the Roth IRA so you can get started with full confidence. I’ll also show
you how easy it is to open a Roth IRA - in fact, you can do it in MINUTES. And finally,
we’ll wrap things up with some Roth IRA investing strategies that will help you earn even more money
from your investments, so that you can retire with more wealth than you’ll ever need. Stick around!
Roth IRA Explained So I think the first
thing that intimidates people about a Roth IRA is the name, because admittedly it does
sound a little complicated! An IRA is simply an individual retirement account. This is a type
of investment account that you set up with the sole purpose of funding your retirement.
Once you open one of these accounts, it’s very similar to any other type of investment account.
With the money you put into your IRA, you can invest in stocks, bonds and even real estate.
And I think this is another thing that trips a lot of people up - investing
in a “roth IRA” sounds complicated, but in actuality, you’re still making very simple
and common investments, just inside of a special account. Again, to be clear,
the IRA is just the account that holds your investments, it’s not the investment itself.
So if you’re already familiar with the idea of investing in stocks or index funds or other
financial products, an IRA is just another vehicle for doing that. But what’s most important about
IRAs is the enormous tax benefits they give you. And this is the single reason why investing with
a Roth IRA can make you so much money. Let’s take a close look at this so you fully understand how
big these benefits really are. Keep in mind, we are going to use the median U.S. income of $68,000
for current tax rates. These tax rates will be accurate for anyone making between roughly $40,000
and $84,000 a year, which includes myself and I’m sure most of you watching this video.
With standard investment accounts, that is a non-IRA, this is what your investment process
would look like. You would receive your paycheck, which you paid a 22% income tax on. Then, you buy
some stocks in your standard investment account. If that stock pays you a dividend, you will either
owe a capital gains tax of 15% or an income tax of 22% on that dividend, depending on the stock. So
right there is a piece of your investment growth that you do not get to hold onto.
Then, whenever you decide to sell your stocks, you will again owe a 15% capital gains tax,
or a 22% short-term capital gains tax if you held that stock for less than a year.
So for standard investors, taxes are affecting your portfolio left and right.
With a Roth IRA, things get a lot better. Again, you would receive your paycheck,
which you paid the 22% income tax on. But here’s where it’s different - after you put
your money into your Roth IRA, everything that happens after that point is 100% tax-free. So,
you can then buy stocks in your Roth IRA just like you would in your standard investment account.
But this time, whenever you receive a dividend from your investments, you keep 100% of it. This
means you can reinvest those extra few dollars into your portfolio instead of paying it to
the government. Furthermore, when you reach retirement and you’re ready to use this money,
you can sell your investments without paying any taxes whatsoever on your earnings.
And what this means is that the interest on your investments compounds faster over time,
creating more wealth than would ever be built in a standard investment account.
So let’s compare some real numbers between the two:
Starting at the age of 25, if you invested $6,000 a year into a standard investment account,
it would grow to approximately $892,000 by the time you reached the age of 60.
That’s using the markets historical 9% return, which includes dividend
reinvestment and adjustments for inflation over the last hundred years. Not too bad.
But, if you started at 25 and invested $6,000 a year into a Roth IRA,
it would grow to approximately $1.41 million by the time you reached the age of 60.
That’s 50% more money than you could grow in a taxable account,
and that’s entirely due to letting your money compound tax-free over the years.
So if you’re investing for retirement, which I would say we all should be, doing it within
a Roth IRA is the most efficient decision. And because the market has a 100-year track record,
it’s pretty safe to assume that it will perform similarly and keep delivering these returns
when averaged out over a 30 to 40 year period. All you have to do is invest in
a total market index fund like the S&P500 to secure yourself those consistent annual returns.
And while I’ve got your attention, I also want to explain the standard IRA,
which is a little different from the Roth IRA. I still think the Roth IRA is the
better option for the average person, but you’ll see why in just a minute.
The traditional IRA has an advantage right off the bat:
you don’t pay any income tax on the money that you invest into this account.
Whereas both Roth IRAs and standard accounts are funded with your post-tax income, anything you put
into a traditional IRA is 100% tax-deductible, so you will effectively invest this money tax free.
Simply put, this means you will be able to invest more money at the beginning,
without having to earn more money. Then, just like the Roth IRA, this money will build over
time completely free from taxes. The exception comes when you get to retirement and you begin
withdrawing from your traditional IRa, because any withdrawals will be taxed at your income level.
So your investments will grow just as fast, but you will have to pay taxes on them in the end.
And ultimately both Roth IRAs and traditional IRAs are very powerful investment accounts for
building your retirement fund. The choice between these accounts will come down to two things:
the income tax bracket you are in NOW, and the income tax bracket you will be in when you retire.
As I mentioned earlier, people making between $40,000 and $84,000
are in a 22% income tax bracket. You’ll be paying income tax on this money today either way.
If you set up a Roth IRA, once you retire, you can withdraw that money without any tax consequences.
So if you really want to ball-out when you hit retirement, you can take out as much money as you
want and not have to stress about owing income tax. This is particularly ideal for people who
(1) are in lower tax brackets today and not paying too much, like the 12% or 22% tax brackets and (2)
people who want the flexibility to withdraw a lot of money in retirement.
And considering how much wealth these accounts can accumulate, you may want to have that option.
On the other hand, a traditional IRA will allow you to reduce your taxable income today.
So if you make $60,000, instead of paying taxes on $60,000 this year,
you could invest $6,000 into your traditional IRA and only pay taxes on $54,000. This will
reduce your tax bills until retirement. But, when you retire, you’ll owe income tax for whatever
amount of money you take out. So if you retire and start taking out $60,000 a year to match
your pre-retirement salary, you’ll owe the same 22% income tax as you have owed all your life,
which makes it kind of a wash. But, if you want to take out money in retirement that is
above your current tax bracket, a traditional IRA can be a bad idea. This is because you're
wasting your tax break today on a lesser salary, and you’re going to end up paying more when you
retire and you start withdrawing money that places you in a higher income tax bracket.
So for these reasons, a traditional IRA is really best for people who make a lot of money today,
like hundreds of thousands of dollars kind of money, because they’ll save more money on their
tax-deductible contributions than they will owe for taking out their savings during retirement.
So hopefully that clarifies the difference between the types of IRA accounts. And like I said,
I think the Roth IRA is generally the better option for anyone making an average income,
because you really only benefit from the tax savings of a traditional IRA if you are in a
really high tax bracket. Roth IRA Rules
However, there are still some rules to the Roth IRA that I’d like to go over.
While it really is as easy as investing your money regularly and letting it grow, there
are some restrictions and rules when it comes to these accounts that you should be aware of.
The first rule is that the annual contribution limit is currently at $6,000.
This means you can only invest $6,000 a year into this account. If you’re over the age of 50,
you’re allowed to contribute $7,000 a year for “catch up” contributions. This number usually
increases every few years, for example it used to be $5,500 from 2013 to 2018. I personally
like that this number isn’t too high, because it makes it a very achievable goal to max out that
contribution limit every year. $6,000 is about 12% of my annual income, which is just about in
line with what many people recommend saving from your salary. So I plan on hitting this limit every
year, and with the huge tax benefits that IRAs offer, you might want to consider doing the same.
And the next rule has to do with income limits. You cannot contribute to a Roth IRA if you are
single and making more than $139,000 a year, or married and making more than $206,000 a year as
a couple. And honestly, this isn’t a big deal, because if you’re making this much you should
probably be investing in a traditional IRA anyway. Interestingly, if you are married,
but only one person makes the bulk of the income, that person can contribute to both their Roth IRA
and their spouse’s Roth IRA with their earnings. So that’s a great way for couples to max out their
retirement savings if one person doesn’t work full-time or whatever else might be the case.
The next rule is that any money you contribute to your Roth IRA must be earned income.
So if you own rental properties or live off of your investments, you can’t contribute the money
from those ventures into your Roth IRA. If you’re employed or self-employed, you’re good to go.
So those are the basic contribution rules,
but the bulk of rules address how you are allowed to withdraw from this account.
Obviously the tax benefits are so generous, that there are rules in place to make sure you are
using them appropriately. So, before you begin withdrawing from your account, you have to have
the Roth IRA opened for at least 5 years prior, and you must also meet one of these criteria:
You must be 59 ½ years old You have become disabled
You have died, and the assets are passed to a beneficiary
OR you are withdrawing money for a first-time home purchase. The catch
here is you are limited to $10,000, and you can only do this once in your lifetime.
If you don’t meet these criteria, and you decide to withdrawal money anyway,
you’ll end up owing income tax on those earnings AND an additional 10% penalty. Obviously this is
a pretty costly decision, so you should plan to keep your Roth IRA locked up as long as possible.
However, there are two ways you can withdraw money from your Roth IRA early without penalties.
I still think this should be a last resort, because you really want this money to grow
as long as possible, but it’s good to know about these options in case you need them.
The first is that you can withdraw any money you’ve put into your Roth IRA from the current
tax year. So if you get halfway through 2020 and realize you didn’t want to max
out your contributions, you can pull out that $6,000 without any penalties. As long as you’re
still in that current tax year, it will just be like the initial contributions never happened.
But you can’t pull out anything extra, only the exact dollar amount you’ve contributed so far.
The second way you can withdraw money early is if you use it for certain approved expenses.
These are pretty specific, and they include:
To pay for health insurance if you’ve lost your job
To pay for up to $5,000 of childbirth or adoption expenses
To pay for qualified higher education expenses, like tuition or books
Or to pay for medical expenses that exceed 10% of your gross income for that year.
So that’s just about everything you need to know in terms of the benefits and rules
surrounding Roth IRAs. Now if you’re ready to get started with this awesome investment account,
let me tell you just how easy it is. How to Open a Roth IRA
All you need to open a Roth IRA account is the following documents or information:
Your employment information, since you’ll be contributing earned income
Your social security number
Your bank account information so that you can fund your account
And you may need your license or passport handy to prove your identity
But when you have this information ready, you can open an account in a matter of minutes.
The only thing left to decide is where to open it! You can open your Roth IRA account at just about
any brokerage in existence, with the exception of some newer ones like Robinhood. So it really
comes down to your investment style and how involved you want to be in your investments.
If you’re overwhelmed by the thought of selecting your own investments,
you might want to choose a “robo-advisor” which will diversify your investments safely for you.
Some of these popular services include Wealthfront and Betterment.
I personally used Betterment when I first opened my Roth IRA and it was super easy. You just answer
a few simple questions about your risk tolerance and they take care of the rest. The only thing I
didn’t like was that they charged a fee of .25% - and it may not sound like much, but that’s just a
few more dollars that are getting taken out of your investment and slowing your growth.
In fact, a study by Nerdwallet found that just a 1% annual fee cost investors over $500,000 over
a 40 year period. So we can conclude that a .25% fee can cost over $100,000 over a 40 year period.
At my age, a Roth IRA is just under a 40 year investment - and I’d certainly like
to have 100,000 more dollars when I retire, so zero-fees are a must!
For this reason, I’m currently using M1 finance, which I like because it has no fees
and it offers fractional shares. So if you’re only investing small amounts each month,
this makes sure every dollar gets put to use as soon as possible. They also have a cool
balancing feature, where any dollar you invest will get properly allocated across your portfolio
to keep you at your desired diversification strategy. This is a huge help because it
automates what would otherwise be a cumbersome maintenance task, so I have full control over
exactly what I’m investing in but I can still do it with pretty minimal work.
But to be honest, I’m not totally in love with M1 finance, so I might actually switch in the
next few years if I come across another brokerage that wins me over. Brokerages like Merrill Edge,
Fidelity, Vanguard and TD Ameritrade are all respected platforms for Roth IRAs and investing
in general. So if you want to open your Roth IRA with a trusted and long-standing brokerage,
you might want to start with one of these guys. Like I mentioned with Betterment,
I would just suggest that you open your account wherever you can find the absolute lowest fees.
Luckily, fees are getting slashed across the board, so zero-fees shouldn’t be too hard to find.
But now you should be totally prepared to open your Roth IRA,
start investing in it and fully understand the benefits behind doing it.
Before we wrap up, I want to share a few tips for the investor-savvy individuals
who are looking to be a little more involved in their Roth IRA investments.
The main strategy I want to share here is simply a reminder that none of your investments will be
taxed inside your Roth IRA. And this is really advantageous for investors who want to put their
money into income-producing or dividend paying stocks. Now most dividend paying
stocks pay out qualified dividends, which as we said earlier, are taxed at the 15% capital gains
rate for most people. So you already know you’re getting these dividends tax-free in a Roth IRA.
But, there are also some stocks that pay out unqualified dividends,
which are taxed at the income tax level. These include real estate investment trusts, or REITs
and business development companies, or BDCs. These stocks have special laws governing them
that force them to pay out 90% of their profits to shareholders in the form of dividends. That’s
really exciting for investors, because it means that the dividends are much larger than the
dividends you would see from most other stocks. But, since these dividends are taxed as income,
they’re not really too attractive for someone investing in a standard account,
because you’ll end up paying more taxes on these dividends, which will reduce the amount
of money you get in your pocket to be more in line with that from qualified dividends.
That is, until you hold them in your Roth IRA portfolio! By investing in these high-income
stocks in your Roth IRA, you get the full dividend payments without any tax obligations.
And this is a great way to get some serious cashflow into your Roth IRA
to help increase the magical effect of compound interest. So this is my personal favorite way for
getting a leg up on my Roth IRA investments that would be impossible anywhere else. And
if you want to learn more about this strategy or stocks like REITs and BDCs,
I have videos on both of these subjects so I’ll link them in the description for you.
But that should cover all the bases for getting started with Roth IRA investing
and hopefully you are prepared to start building up millions for your
retirement. If you have any questions about Roth IRAs that I did not answer,
please drop them in the comments and I will be sure to respond there or in a future video.
Of course you will also want to make sure you subscribe to the channel to make sure
you don’t miss anything valuable. Until then, happy investing and I will see you next time.