A Roth IRA account is a great way to create a million dollar retirement.
Types of IRAs –
There are two main types of IRAs, a traditional IRA and a Roth IRA. The taxes on these two accounts work differently.
Contributions to a traditional IRA are tax deductible now, and taxes are paid when you take withdrawals.
Contrarily, contributions to Roth IRAs are not deductible now. You pay tax on the money before you contribute to the Roth. In exchange for paying your taxes this year, the government lets you take money out tax free when you are old enough. (A long list of rules and restrictions exist for both IRAs. The above is a simplified description.)
Choosing an IRA type –
Why choose a Roth IRA over a traditional IRA? It depends on your situation, but paying your taxes now may be beneficial. Most people imagine they will be making more money in the future.
How unsatisfactory would your retirement be if you have to live on the same amount of money you were making in your thirties? Instead, most of us plan on increasing our incomes and wealth throughout our careers.
When you will have more wealth in the future, you should choose a Roth IRA over the traditional IRA. (If your income makes you ineligible for one, consider a backdoor Roth IRA). Under this situation, you will be paying taxes at today’s income rate and then withdrawing it when you are in a higher tax bracket. Tax-free Roth IRA withdrawals will be advantageous.
IRA income and contribution limits for 2019 –
The income cut off limits for 2019 are $137,000 for single filers and $203,000 for MFJ. Each year you have earned income less than the cutoff, but greater than $6,000, you can contribute $6,000. If you are 50 or over, you can contribute an additional $1,000.
Contributing $6,000 may not sound like it could produce a large account, but adding $6,000 to the account each year adds up over time.
Account size calculations –
Let’s look at some calculations to see just how much we can save by retirement. And remember, this amount will be tax free!
| $6,000/ yr | Age 30 to 67 | Investment return = 0% | Value = $220,000 |
Without earning any interest or investment return, we would have saved $220,000 by contributing at age 30 until full retirement age of 67. Being able to save $6,000 per year, or $500 per month should be possible from age 30 and onward. If not, you need to do some budgeting work.
Now let’s change our return to a fairly conservative 5%.
| $6,000/ yr | Age 30 to 67 | Investment return = 5% | Value = $640,257 |
Wow. Over half-a-million, tax-free dollars could be yours for saving $500 per month and investing conservatively. By conservatively I mean 30% US stocks and 70% intermediate Treasuries. According to Portfoliovisualizer.com, that allocation would have been enough to produce a 5% inflation adjusted return.
Next let’s change the investment return. Since this is a long-term account, the proper investment strategy would be to invest aggressively in a high percentage of stocks. With a more aggressive 8% return, the following account values are possible.
| $6,000/ yr | Age 30 to 67 | Investment return = 8% | Value = $1,315,895 |
Check out that result! (In reality this number could actually be higher than $1.3 million because the contribution limit will not remain at $6,000 for the next 37 years. It has increased at 4% per year since 2002 when it was $3,000.)
Calculations for starting late –
What if you are not thirty anymore, but 40 years old instead? Let’s take a look at how much you could save.
| $6,000/ yr | Age 40 to 67 | Investment return = 8% | Value = $566,032 |
Or alternatively, you are now 50 years old and trying to make a big push to accumulate a nice nest egg before retiring at age 67. That gives you 17 years of contributions and a contribution limit of $7,000 because you are now eligible for the catchup contribution.
| $7,000/ yr | Age 50 to 67 | Investment return = 8% | Value = $255,151 |
That’s over a quarter of a million dollars tax-free for your retirement. If you didn’t touch that money for an additional ten years, it could be worth $550,851.
That’s a good sum of tax-free money that could be used to pay for health care, long-term care, nursing or home health care or other expenses in old age.
Conclusion –
These calculations show us that it is possible to accumulate a tax-free 1 million dollars for retirement with annual savings and investing in a Roth IRA account.
Remember, these values are only in your Roth IRA. You will also have your 401(k) and other investment accounts. It is definitely worth your effort to open a Roth IRA account, contribute the maximum each year, and invest in it aggressively.
If you would like to talk to me about this or other investing ideas, call (760) 651-6315.