It is easy to forget that words, phrases, and other things you say may be general knowledge in your head, but that does not mean it is for the next person. This is one reason why good teachers have a valuable skill that many lack. They are able to breakdown complex things to their students and teach them something previously unknown. This skill is difficult to master, and it is one I envy from my teacher wife.
Disclaimer: Although I do talk about taxes more in this article than my other posts, do not take this article as specific advice. I am writing in general terms on what I know about the subject.
The word "Roth" is thrown out so much in the personal finance world that people just assume it is common knowledge. There are general things about a Roth that seems to be common knowledge, but there are other characteristics that are not universally known.
Some Common Knowledge About A Roth
Most people who have heard of the word "Roth" know that it has something to do with investing, retirement, or money and it is a good thing. That is it. If you do not know more about a Roth than those two things, you are not alone. So, do not get down on yourself.
Some Less Common Knowledge About A Roth
Roth is a designation to certain investment accounts. A Roth designated account means all withdrawals in retirement are tax-free as long as you meet certain criteria. Generally, you must not take the money out until after 59 and 1/2 years old and have the account longer than five years.
Since Roth is a designation, there are different types of Roth options. The two most well known Roth options is a Roth IRA or a Roth 401(k) (there is also a Roth 403(b) option for some government employees).
If you make a Roth contribution, you are agreeing to pay taxes on the dollars going into the account in exchange to make tax-free withdrawals during retirement. If you run the math, with compounding interest this can be a very powerful tool in retirement.
With all the good things that come with a Roth designated account, there are some restrictions as well, such as income limitations and how much you are allowed to invest into the account. With a Roth IRA, if your income (or combined income if filing jointly) is over a certain amount, you cannot contribute to a Roth IRA (if you are over the income limit, it may be worth talking to a professional about how to do a Backdoor Roth IRA). The IRS changes this amount yearly.
Additionally, the government limits the amount of money you can put into a Roth designated account due to how powerful dollars in a Roth account can be. Roth IRAs have a 2023 contribution limit of $6,500 ($7,500 if 50 or older) and Roth 401(k)s have a 2023 contribution limit of $22,500 ($30,000 if 50 or older). Again, this amount changes every couple years.
Another thing to remember is if you withdraw any money from your Roth IRA early, you are subject to pay hefty penalties. Therefore, you should plan to keep any money you put into a Roth IRA there until retirement age.
How To Open A Roth IRA
Okay, let's say you like what you hear about a Roth IRA and wish to start investing in your retirement immediately. Here are the general steps you will need to take:
Research whether you are eligible to contribute to a Roth IRA. Other than the limitations I mentioned above, another criteria is that any contributions made must be with "earned" income.
If eligible, pick out which investment firm you are comfortable using. Most people use one of the big three brokerage firms - Vanguard, Charles Schwab, and Fidelity (I use Vanguard and Schwab). If you plan to invest in mutual funds and prefer Vanguard funds over Fidelity, you will want to open up a Vanguard account because other brokerage firms will usually charge a fee to use other firm's mutual funds.
Go to the brokerage firm's website that you have chosen, and go through the options to set up a Roth IRA account. Be prepared to answer a series of questions about income and how you plan to contribute to the account.
Once the account is set up, you will need to link your bank account to the new account. This is the easiest way to make contributions in the future.
Once the bank account is set up, search for the mutual fund or ETF you would like to invest your Roth dollars into. A lot of long-term investors use low cost index funds that track the S&P or the total stock market index. Historically, making monthly investments into these types of funds for the long-term has been very rewarding.
Invest your money into the chosen fund. I also suggest setting up automatic contributions. Once you make investing automatic, you are setting yourself up for a lot of success.
Final Thoughts
Investing is not as scary as it seems. Investing in your future actually gives you peace of mind and helps you sleep at night.
People try to overcomplicate simple things. If you ever get financial advice from someone who makes things sound convoluted, you should run. Any person who talks in absolutes (such as using phrases like "guaranteed return") and uses complex terms to explain investing is a salesman, not an advisor.
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