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Money Girl

273 MG Your Guide to the Roth IRA, Part 2

Fast track your retirement savings with this tax-advantaged account.

Broadcast on:
19 Jun 2013
Audio Format:
other

Fast track your retirement savings with this tax-advantaged account.

Hey, Fidelity, what's it cost to invest with the Fidelity app? Start with as little as $1 with no account fees or trade commissions on US stocks and ETFs. Hm, that's music to my ears. I can only talk. [MUSIC] Investing involved risk, including risk of loss, zero account fees apply to retail brokerage accounts only. Sell or assessment fee not included, a limited number of ETFs are subject to a transaction-based service fee of $100. See full list at Fidelity.com/commissions. Fidelity brokerage services LLC, member NYSE SIPC. [MUSIC] Hi, everyone. I'm Laura Adams, and you're listening to the Money Girl podcast. [MUSIC] This is the second episode in a two-part guide to the Roth IRA. In the first episode, I covered what a Roth IRA is, who can have one, and the rules for making withdrawals. Today, you'll find out when you should opt for a Roth IRA. The types of investments a Roth has ideally suited for, and where to get one. As you learned in Part 1, an IRA is a special account that helps you build a healthiness tag by cutting your taxes. Contributions you make to a Roth IRA are never tax deductible, which means they're taxed before going into the account. However, your earnings and the account grow completely tax-free, and then you can take withdrawals during retirement without owing a penny to Uncle Sam. These rules are the opposite of a traditional IRA where contributions are tax deductible, but you pay tax on both contributions and earnings when you take withdrawals in the future. Since a traditional and a Roth IRA both have fantastic advantages, you may have a hard time knowing which one to choose. There are five situations when it does make sense to opt for the Roth. The first situation where you'll want to consider contributing to a Roth IRA is number one when your income is low. If you're earning less today than you believe you'll earn in the future, then the Roth is probably your best choice. That's because you're in a relatively low tax bracket right now, compared to what it could be in the future. Therefore, if your tax rate is low now, it's cheaper to pay tax on Roth contributions than to pay tax on withdrawals from a traditional IRA in the future when your tax rate may be much higher. Situation number two for when the Roth IRA makes sense is when you're young. If you're just starting your career, not only is your income generally low, but you have decades to go before retirement. If your Roth IRA account value explodes over time, you'll avoid paying tax on a heap of money. For instance, if you invest $400 a month for 40 years, that's a total of $192,000 that you put away in your Roth IRA. Now if you earn an average return of 7%, your account would be worth over a million dollars after four decades. The difference between the account value and your contributions is massive over $800,000 and every penny of those investment gains would be exempt from tax because it's in a Roth IRA. If your average tax rate were 15%, that's a savings of over $120,000. The third situation to think about using a Roth IRA is when you don't need a tax deduction. The best part about a traditional IRA is getting a tax deduction in the current year. That can be a godsend when you don't have any other tax deductions or credits to shrink a big tax bill. But if you already have plenty of ways to trim your taxes, like mortgage interest, medical expenses or tax credits, then making Roth IRA contributions would be an advantage. The fourth good circumstance for a Roth IRA is when you participate in a retirement plan at work. If you or your spouse make contributions to a workplace retirement account, like a 401(k) or a 403(b), and you earn over a certain amount, some or all of your traditional IRA contributions may not be deductible. With a Roth IRA on the other hand, there's no limitation to maxing it out and contributing to a retirement plan at work in the same year. I did a previous podcast with more information on this topic called "Should You Contribute to Both a 401(k) and an IRA?" If you want to go back and listen to it, it's episode number 216 on the Money Girl page at quickanddirtytips.com. And remember, if your employer offers to match contributions you make to a workplace retirement account always contribute enough to max out the match before contributing to an IRA, otherwise you're leaving money on the table. And the fifth situation for a Roth IRA is when you want the option to withdraw funds before retirement. Since you pay tax upfront on Roth IRA contributions, you can withdraw them at any time without paying additional tax or penalties. That means you could easily use the money to buy a home, pay for education, or start a business. Of course, I don't recommend withdrawing funds from a retirement account unless you already have a healthiness tag somewhere else. And as you learned in part one of this episode, withdrawing earnings from a Roth IRA before the official retirement age of 59.5 generally triggers income tax and a 10% early withdrawal penalty. Now, let's talk about the best investments to own in a Roth IRA. Since the Roth offers tax-free account growth, you'll get the most tax savings by owning investments that could potentially mushroom in value, such as growth stocks and funds. Other smart choices are investments that pay dividends, like bonds, bond income funds, and dividend stocks. All of the investment growth and income that you hold in a Roth IRA will be tax-free when you decide to take withdrawals in retirement. If you're ready to start taking advantage of the awesome benefits of a Roth IRA, you can open one through an investment advisor or at many different banks, mutual fund companies or online brokerages. Opening a Roth IRA is just as easy as opening a bank account. You complete an application and transfer funds to activate the account. Work for a company that offers the kinds of investments that you want to make, like mutual funds, exchange-traded funds, or stocks. And if you have no idea what investments are right for you, choose a company that offers free personalized advice and gives you simple options, like our sponsor Betterment.com. Go ahead and put your Roth IRA on autopilot by setting up recurring monthly deposits. In some cases, signing up for an automatic investing program will reduce or eliminate any minimum balance requirement. 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For more money tips, tools, and advice, visit my blog at smartmoves2growrich.com and download two free chapters from my book by the same name, Money Girls Smart Moves to Grow Rich. While you're there, click the button that says "Tools" to get over 25 of my favorite personal finance and productivity tools to earn more, save more, and accomplish more. Also, be sure to follow me on Pinterest, Facebook, Google+ and Twitter. I'm glad you're listening to change. That's all for now. Courtesy of Money Girl, your guide to our richer life. Betterment LLC is an SEC registered investment advisor. Brokerage services are offered by Betterment Securities, an SEC registered broker-dealer, and member FINRA SIPC. Investments are not FDIC insured and have no bank guarantee, they may lose value. Investing in securities involves risks, and there's always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and Betterment's charges and expenses. Not an offer, solicitation of an offer, or advice to buy or sell securities in jurisdictions where Betterment and Betterment securities are not registered. [BLANK_AUDIO]