Perhaps you’ve heard of Roth IRAs but don’t know a lot about them. Are you eligible? What does setting one up entail?
A Roth IRA (Individual Retirement Account) refers to a retirement plan which grows tax free. This differs from a 401(k) in that money placed into a 401(k) is funded by pretax dollars from a person’s paycheck. Money placed in a Roth IRA is taxed up front but none of the earnings are taxed when withdrawn at retirement. Contrastingly, earnings in a 401(k) account are taxed when withdrawn.
Anyone with an earned income may put money into a Roth IRA. The maximum limit is the total amount of income earned in a year or $4,000 (for 2007, increases to $5,000 in 2008) or $5,000 for those age 50 and above. Earned income is currently limited to $99,000 if filing singly and $156,000 if filing jointly.
Investment options within the Roth IRA can include a wide variety of options such as individual stocks, mutual funds, bonds, money market accounts, savings accounts, cds among others. If the individual is not familiar with how these retirement vehicles work, he or she would do well to consult with a financial counselor with the heart of a teacher. These professionals can help to explain concepts in easy to understand terminology and devise good investment strategies.
By starting early with a Roth IRA, the person can harness the power of compound growth potential. For example, say you start with $2,000 in the account and it grows 10% per year for 40 years. At the end of the first year, the amount will be worth $2,200. Assuming growth of 10% 40 years from today, your original investment of $2,000 will be worth $107,401.33.
This is assuming no additional investment. Just imagine the potential if investing regularly each year. Assuming a $2,000 annual investment at 10% growth rate, this will amount to $1,064,222.13 tax free.
One caveat to keep in mind is that the money is not generally dispersible until age 59 except for in cases of purchasing a first home or paying for educational expenses. It is important to leave the money alone even in market downturns and allow it to grow as a long term investment vehicle.
Websites such as www.daveramsey.com and www.crown.org offer excellent advice and calculators which help in researching good options in which to invest.
If you begin early or even later in the game, Roth IRAs are excellent options to provide a solid nest egg for retirement.