What is a Roth IRA & How Does It Work?

Investing for the future is crucial to securing your family’s future, but where does the Roth IRA come into play?

Whether you’ve nailed one of those six-figure jobs or are determined to generate a passive income, saving money for your eventual retirement is critical if you want a happy one.

This guide answers questions like, “What is the best Roth IRA for beginners?” and discusses the Roth IRA vs. traditional IRA.

What is a Roth IRA?

An IRA is an Individual Retirement Account that allows you to contribute dollars after tax in exchange for tax-free investment gains in the future. The Roth variant was launched in 1998, and with 20.5% of American households possessing one, this is the most popular IRA today.

Under the rules, you must have held your IRA for a minimum period, and when you reach age 59.5, you can take distributions and earnings without being eligible for federal taxes.

This system differs from a traditional IRA, where you receive a tax deduction when you contribute but still pay federal taxes on distributions.

How Does a Roth IRA Work?

Is it good to invest in a Roth IRA? Like deciding whether to invest in ETFs or gold, it depends on your personal investment strategy.

Someone who’s decided to start freelancing may have a different strategy from those working out how to create a personal budget while in traditional employment. But the first step is to learn how this IRA works.

So, how does it work?

Step One – Contribute after-tax dollars to your account.
Step Two – Invest the money sitting in your IRA.
Step Three – Wait for those investments to generate a return.
Step Four – Make qualified withdrawals after age 59.5 and pay no federal taxes.

One of the enormous benefits of this IRA is that you can always withdraw contributions. Since these have already been taxed, there’s no penalty or tax for taking contributions from your IRA. The 59.5 rule only applies to investment earnings.

What is the Roth IRA Limit 2023?

A Roth IRA calculator can give you a basic idea of your returns, including factoring inflation into the calculation. But you cannot just throw all your spare dollars into this IRA. Limits on contributions exist, depending on your circumstances, including filing status and income.

Single/Head of Household/Married Filing Separately – $6,500 if earning less than $138,000 annually. Your contribution limit decreases until it expires at the $153,000 limit.
Married Filing Jointly/Qualifying Widow(er) – $6,500 if earning less than $218,000 annually. This limit decreases until it disappears entirely at $228,000.
Married Filing Separately (If living with your spouse) – Reduced contributions at less than $10,000 annually. No contribution is allowed if you earn more than $10,000.

Note that those aged 50 and older can contribute an extra $1,000 for catch-up contributions.

Benefits of a Roth IRA

Many ask, “What is better, a 401(k) or a Roth IRA?” However, the benefits vary based on how you approach investing and retirement.

The top Hispanic financial influencers and Asian-American figures like Marguerita Cheng all recommend adding this IRA to your arsenal if you qualify.

Here are some of the reasons why:

Withdraw as little or as much as you like: no minimum distributions or a requirement to touch your account while you’re alive.
Don’t worry about how to do your taxes because Roth IRAs provide zero federal income tax liability if you take distributions.
You can withdraw any money that you’ve contributed at any time. No questions asked.
Double dip all day. You can contribute to other retirement accounts like 401(k)s and hold your IRA.
You can contribute before that year’s tax deadline, usually around April.
No concerns regarding your credit history. You don’t need to visit credit repair companies to get accepted for an account.
Open one of these IRAs whenever you want. There’s no lower or upper age limit for new applicants.

In short, this is one of the best ways to make money online with minimal effort. Unless you’re an extremely high earner and no longer qualify, this is one of the best retirement accounts available.

How to Start a Roth IRA

Before you create a budget for your brand-new retirement account, remember the golden rules of this IRA:

Investment earnings cannot be withdrawn tax-free until you reach age 59.5.
Contributions can be withdrawn anytime.
IRAs may be passed onto your heirs.

This IRA is a tax wrapper to defend you against federal taxes. It’s one of many ways to protect yourself from federal tax raids on your hard-earned dollars.

Opening one is as easy as approaching an IRA provider and showing that you meet the income requirements. Other than that, activating your account only takes a few hours to a few days.

However, your choice of account matters. Hands-off investors may want to look into robo-advisors like Betterment or SoFi. But if you’re interested in a more hands-on approach, here are some Forbes recommendations for the best IRAs in 2023:

Fidelity Investments
Charles Schwab
TD Ameritrade

All three above accounts have no minimum account balances and zero trading commissions, making them an ideal place to start.

Some securities you can add to your account include stocks, bonds, ETFs, index trackers, and mutual funds.

How much will a Roth IRA grow in 10 years?

After ten years of contributing the maximum of $6,500 per year, you’d have about $90,000 at a 7% annual return. This means you’d have gained around $15,000 from doing nothing.

How much will a Roth IRA grow in 20 years?

Assuming a 25% marginal tax rate, based on how U.S. tax brackets work and the same parameters as above, how much can you expect to have after 20 years?

Your total contributions in your final year would be $130,000. But the amount you would have earned with an average 7% annual return would be $142,971 for a total account value of $266,471.

Conclusion

Turn discussions about personal branding and social media presence into talks about dollars and cents, as the latter truly matters.

At Urban Income, we specialize in supporting minorities by showing them how to use their money to maximize their potential. Whether it’s investing, retirement, or basic budgeting, our experts are here to guide you.

To learn more about planning for your retirement, browse Urban Income today.