As you move into your 30s, your list of financial goals may include things like paying off the rest of your student loan debt or buying a home, but there’s one more thing you can’t forget: saving for retirement. Here’s how to build wealth that you’ll need.
If you have access to a 401(k) or similar plan at work, that’s a good place to start. According to the 17th Annual Transamerica Retirement Survey, 72 percent of Millennials and 77 percent of Gen Xers are already funding their workplace plans.
But what if you don’t have a retirement plan at work? How then can you build wealth in your 30s and beyond? Or what if you want to save even more than you’re permitted to in a 401(k)? A Roth IRA may be the answer.
Roth IRA Benefits
As a wealth-building tool, a Roth IRA is attractive for several reasons.
First, any qualified distributions you make are 100 percent tax- and penalty-free. To count as a qualified distribution, your account must be open for at least five years and the withdrawal must be made after you turn 59½, or because you’ve become permanently disabled or if you’re taking a distribution to buy a first home (more on this just below).
Unlike a Traditional IRA, there are no required minimum distributions for Roth IRAs. That means you can leave your savings in your account for as long as you live. You can keep saving in a Roth IRA indefinitely, as long as you have qualifying earned income and your modified adjusted gross income doesn’t exceed the annual limit for making contributions. With a Traditional IRA, you have to stop contributing money at age 70½, even if you’re still working.
You can always withdraw your original contributions to your Roth IRA tax- and penalty-free at any time. However, if you’re withdrawing earnings before age 59½ and before your account is five years old, you may pay taxes and penalties on the distribution. You can, however, avoid the penalty if you’re withdrawing money to buy a first home, cover qualified education expenses or pay for unreimbursed medical expenses and health insurance premiums.
One thing to keep in mind: Just because you can withdraw your contributions at any time doesn’t necessarily mean you should. There are two specific downsides to doing so. First, you miss out on the power of compound interest, which can go a long way towards increasing your wealth over time.
The other downside is that you can’t put a lump sum back into your Roth after you’ve taken it out. If you were to withdraw $10,000 to buy a home, for example, you couldn’t replace it all at once. You’d only be able to save the annual contribution limit for the year.
Build Wealth with a Roth IRA in Your 30s
Roth IRAs have many positive features but the real question is, how can you use one to build wealth, and why should you choose a Roth over a Traditional IRA?
Answering the first part of that question just requires some simple math. Currently, the maximum annual contribution limit to a Roth IRA is $5,500. Now, assume you save that amount starting at age 30, and you retire at age 68. If you were to earn a 7 percent annual return, that $5,500 annual savings would grow to over $1 million. That’s not too bad for what effectively breaks down to a little over $100 a week in savings.
Of course, you could save that same amount in a Traditional IRA and besides, you may be able to deduct those contributions. Deductions reduce your taxable income for the year, potentially putting you in a lower tax bracket.
The catch is that you pay taxes on withdrawals from a Traditional IRA in retirement, including on all the money your contributions have earned over the years. That could be problematic if your income after you stop working puts you in a higher tax bracket.
If you’re still building your career in your 30s and you haven’t hit your peak earning years yet, being able to withdraw Roth IRA assets (your contributions, plus all the income they will have earned) tax-free when you retire may be more valuable in the long run than getting a deduction now.
Do Your Research
When comparing Roth IRAs, pay attention to the fees you’ll pay to save since they can easily eat into your returns. Also, consider the range of investments each account you are considering offers. Having a limited selection of investments to choose from could skew you off-course if the options don’t match your risk tolerance.
The better you understand what’s available to you, the easier it becomes to choose the Roth IRA that can help you achieve your wealth-creation goals.