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Stash money now for tax-free growth and income in retirement

Quick Summary

  • A Roth IRA provides tax-free growth and tax-free withdrawals in retirement.
  • There are no RMDs, so you can leave your money untouched if you don’t need it.
  • It’s a good idea to max out your 401(k) match first, then max out your Roth IRA.

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 one way to build the wealth you’ll need.

Max out Your 401(k) Match First

According to the 17th Annual Transamerica Retirement Survey, 72% of Millennials and 77% of Gen Xers are already funding their workplace plans. If you have access to a 401(k) or similar plan at work, that’s a great place to start. Here’s why:

  • If you get an employer match, you get an automatic 100% return on part of the money you invest in your 401(k).
  • 401(k)s are tax-deferred, so your money grows faster.
  • You get a tax deduction for the year you contribute, which lowers your taxes (and gives you more to invest).
  • There are high contribution limits: For 2019, you can invest up to $19,000, or $25,000 if you’re age 50 and older.

But what if you don’t have a retirement plan at work, or you’ve maxed out your 401(k) and want to save more? A Roth IRA may be the answer.

Coins stacked with lettered blocks that spell wealth indicative to build wealth.

Roth IRA Benefits

As a wealth-building tool, a Roth IRA is attractive for several reasons.

First, any qualified distributions you make are 100% 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 59 ½.

You can always withdraw your original contributions to your Roth IRA at any time, for any reason. However, if you withdraw earnings before age 59 ½ and before your account is five years old, you may owe taxes and penalties on the distribution. You can, however, avoid the penalty if you withdraw money to buy a first home, cover qualified education expenses, or pay for unreimbursed medical expenses and health insurance premiums.

Roth IRA Withdrawals

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 stash away the annual contribution limit for the year.

No Required Minimum Distributions for Roth IRAs

Unlike a traditional IRA, there are no required minimum distributions (RMDs) for Roth IRAs. That means you can leave your savings in your account for as long as you live. And you can keep contributing to 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.

These features make Roth IRAs excellent wealth transfer tools. When your beneficiary inherits your Roth IRA, the distributions can be stretched out over their lifetime. This can provide years of tax-free growth and income for your loved ones.

With traditional IRAs, you have to start taking RMDs when you turn age 70 1/2, even if you don’t need the money. And you have to stop contributing money at that same age, even if you’re still working.

Build Wealth with a Roth IRA in Your 30s

Roth IRAs have many positive features. But the real questions are: How can you use one to build wealth, and why should you choose a Roth over a traditional IRA?

Answering that first question just requires some simple math. Currently, the maximum annual contribution limit to a Roth IRA is $6,000 ($7,000 if you’re age 50 or older). Now, assume you save that amount starting at age 30 and you retire at age 68. If you were to earn a 7% annual return, that $6,000 annual savings would grow to more than $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 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.

A Roth IRA can be a great choice if you’re still building your career in your 30s and 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.

Roth IRA Fees

When comparing Roth IRAs, pay attention to the fees you’ll pay 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.

 

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