Nearly 25 million people own Roth IRAs, according to the Investment Company Institute, but that’s a far cry from the number of Americans who could contribute to one if they wanted. While a Roth IRA isn’t the best retirement account for everyone, it has some distinct advantages that make it worth considering, especially for those who don’t have a workplace retirement plan that matches contributions.
Here are a few reasons you should consider stashing some money in one this year.
1. Almost anyone can contribute to a Roth IRA
While a workplace retirement plan is usually only open to employees, just about anyone can open and contribute to a Roth IRA. The only rule is that either you or your spouse must earn enough income throughout the year to cover the contributions you make to the account. So if you contribute $5,000 to your Roth IRA in 2021, you and/or your spouse must earn at least $5,000 in income this year.
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A Roth IRA is a great option for those who don’t have access to a retirement plan through their employer, though the contribution limits are much lower than those of workplace retirement plans. You may only put up to $6,000 in a Roth IRA in 2021, or $7,000 if you’re 50 or older.
2. You have a lot more investment options
While 401(k)s and other workplace retirement plans often limit your investment options to a few mutual funds, Roth IRAs enable you to invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), and a lot more. The exact options available to you will depend on which broker you work with, but you’re free to make your own choices and change brokers as often as you’d like. Therefore, it shouldn’t be too difficult to find investment options that match what you’re looking for.
Of course, the sheer volume of choices can be overwhelming, especially for those who are new to investing. If you’re overwhelmed, choosing a few low-cost index funds — mutual funds that track a market index — is a good place to begin. Then, as you learn more about investing and become more confident in your ability to choose investments for yourself, you can diversify your portfolio even more, if necessary.
The Roth IRA’s many investment options also give you greater control over how much you’re paying in fees. If you focus on choosing no-commission individual stocks or low-cost index mutual funds and ETFs, you can keep more of your savings in your account where they can generate investment earnings to help you cover your living costs in retirement.
3. It could save you money over the long term
Traditional IRA contributions give you a tax break this year, while Roth IRA contributions do not, but when it comes to withdrawals, things flip. You’ll owe taxes on your traditional IRA distributions, but not on those from your Roth IRA. Understanding this distinction is important because choosing the wrong type of IRA could force you to pay more in taxes overall.
Roth IRAs are usually best for those who think they’re earning about the same or less now than they’ll spend annually in retirement. This can vary from year to year. If you’re still experiencing unemployment due to the pandemic, for example, you might earn less this year than you have in previous years. That could make a Roth IRA a good fit for you this year, even if it wouldn’t have been so advantageous in the past.
Even if you cannot afford to make new contributions this year, you could still take advantage of the Roth IRA’s tax-free growth by doing a Roth IRA conversion. That’s when you convert tax-deferred savings, like traditional IRA or 401(k) contributions, into Roth savings by paying taxes on the money this year. It might not be a smart move if it’ll push you into a higher tax bracket, but if your income is lower this year than normal, doing a conversion could help you save money on taxes in the long run without raising your tax bill this year by too much.
You don’t have to commit to saving exclusively in a Roth IRA this year, but it’s worth adding one to your retirement plan if any of the above benefits appeal to you. If you max out your Roth IRA, you can always switch over to a workplace retirement plan. You could also put some money in a traditional IRA and some in a Roth IRA, but remember that your total IRA contributions for the year can’t exceed the contribution limits discussed above.