When it comes to money, some people are savers and some are investors. (Then there also are some who are neither, but that is another post.) If you have always been a saver, becoming an investor can be a scary proposition. The first step in this process is to flip that switch from saving money to implementing an investment strategy.
I see this all the time in my financial planning practice—people who have been diligent about putting money into a low-interest savings account come to realize that if they ever want to retire, they need to do more with their money. But the volatility of the stock market frightens these people, and the hundreds of different financial options can be overwhelming to them. Too often, these savers remain that way, hoping that somehow the money they deposit in the bank each month will magically multiply into an amount on which they can retire.
I have to tell you that no amount of hocus pocus will grow your low-interest savings account any faster than a couple of percent per year. Fortunately, I have a better plan to increase your money into a retirement-worthy sum. Not only that, but my solution will also seemingly magically erase the taxes you would otherwise have to pay on the growth. And yes, this plan is completely legal.
Presenting…the Roth IRA!
This investment strategy involves putting only $5,000 a year (the maximum allowed) into a Roth IRA and leaving the money to grow tax-free until you need it for retirement. Yes, you heard me right. Every penny in your Roth IRA account is yours—you do not have to pay any of it in taxes. And that is not all. Consider the other benefits of a Roth IRA:
- You have almost complete control over the way the money in your IRA is invested. A Certified Financial Planner (CFP) can work with you to create an investment plan that matches your degree of risk.
- You can withdraw your contributions at any time, without a penalty. Of course it is better to keep your money in the Roth IRA so that it keeps earning, but if you find yourself needing funds, withdrawing part of your contribution is not much harder than going to the bank to take money out of your savings account.
- Once you turn age 59½, you can also begin making withdrawals of your interest earnings. And remember, all the money you take out is tax-free.
- Unlike a traditional IRA, there is no mandatory distribution age, so if you reach age 70 and you don’t yet need the money in your IRA, you can keep it in there to earn more.
Keep in mind that the contributions you make to a Roth IRA are not tax deductible the way contributions to a traditional IRA are. There is also a maximum income ceiling for eligibility. Once you make more than about $110,000 a year if you are single, or $179,000 between you and your spouse, you can no longer contribute to a Roth IRA. But don’t worry—the money you put in won’t go anywhere. It will keep growing, tax-free as always, until the day you need it to retire. Kind of like magic.
Jeff Rose is a certified financial planner and author of the blogs Good Financial Cents and Soldier of Finance. Learn more about his Roth IRA Movement that has inspired over 140 personal finance to educate young adults on the importance of saving.