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Opening a Roth IRA

Opening a Roth IRA

Wednesday, September 14, 2022/Categories: Investing & Planning

A Roth IRA is a tax-advantaged retirement saving plan that lets you save a portion of your taxed income for your golden years. It is typically used by employees to supplement their work-sponsored 401(k) account, but it can also be a great vehicle for jumpstarting your retirement savings fund if you are still in college or are self-employed.

Roth IRAs may not have any upfront tax benefits like some investment vehicles, but the contributions accumulated over the years can be withdrawn tax-free at any time. It is a boon for young investors in lower tax brackets who have decades to go before retirement.

This guide covers the steps you need to take to open a Roth IRA and what to do after you've made your first contribution. However, please note that we do not provide legal or tax advice. Consult your legal and/or tax advisor.

Step 1: Roth IRA or Traditional IRA?

Before you open an individual retirement account (IRA), figure out whether a Roth IRA is better for your savings goals than a traditional IRA. The key difference between a Roth and a traditional IRA is when you have to pay taxes for your contributions.

With a traditional IRA, you only have to pay taxes when you withdraw the money in retirement. On the other hand, a Roth IRA requires you to report and pay taxes on your contributions every year. The flip side is that when you eventually withdraw your funds, your money won't be taxed again. It essentially means your money grows tax-free in your account.

A Roth IRA is the better option for most younger investors because they usually start in a lower tax bracket. If you have reason to believe you'll still be in a low-income tax bracket by the time you retire, then you may want to consider a traditional IRA.  

Step 2: Do You Qualify?

Whether or not you are eligible for an IRA depends on your income. There are income limits set by the federal government that change every few years to keep up with inflation. For the tax years 2020 and 2021, you need to make less than $140,000 to qualify if you are single. For couples, your combined income must be under $208,000. 

There is also a contribution limit that changes from time to time. For example, the amount you could contribute to your account in 2020 and 2021 was limited to $6,000 a year for those under 50. The limit went up to $7,000 if you're over 50.    

Step 3: Which Provider Should You Use?

You're spoiled for choice, because almost every financial institution offers its account holders the option of opening a Roth IRA. Every provider has its pros and cons. When picking a provider, look at factors like customer service, account minimums, maintenance fees, commissions, and available stock/fund/bond options.

These days, there are also online brokers offering Roth IRA accounts. Finding the right provider for your retirement savings needs will take a little research. Make sure you do your due diligence before you let an institution take custody of your money.  

Step 4: Opening An Account 

Every provider has its steps for opening an account, but most of them have digitized the process. That means you can open your IRA right from your home or office by applying online.

To get started, you must provide some form of government-issued ID, your Social Security number, address, and banking information. Only open your account over a secure network to prevent criminals from gaining access to your sensitive information.

You also need to name a beneficiary who will get the money in your account if you die. Make sure to keep your beneficiary designation up to date, especially after events like divorce or marriage.  

Step 5: Making Your First Contribution

Once you've set up your account, it's time to make your first contribution! Deciding what you want to invest in is probably the toughest part of opening a Roth. You can either design your own portfolio by choosing from the available options or buy a life-cycle fund made specifically for people in your age group. Alternatively, you can consult a financial advisor to help you design a portfolio that suits your personal goals.

For safety, try to keep your portfolio diverse by choosing a mixture of stocks and bonds. The type of assets you should invest in will largely depend on your risk appetite and how many years you have left to save for retirement.

Older account holders may want to stick to conservative investments that are less likely to be affected by market fluctuations. If you have doubts, consult with the financial advisor offered by your provider to decide the best options for your situation.  

Step 6: Monitor Your Account 

After you make your first contribution, it's a good idea to set up a contribution schedule that ensures you are depositing the maximum amount allowed every year.

Check on your investments at least once a year to make sure they are healthy. Don't be afraid to rebalance your account if your long-term retirement goals change. Rebalancing may not be necessary if you have a life-cycle fund, but it's still a good idea to check on your account every so often.

Final Thoughts 

Roth IRAs are among the best retirement investment vehicles out there. Almost everyone can benefit from having one regardless of whether they're employed or self-employed, adult or child. It may not have any upfront tax benefits, but the income accumulated over the years is tax-free.

The Roth IRA is especially good for younger people who are in lower-income tax brackets today than they are likely to be when they finally withdraw their funds. They have decades to enjoy the effects of compound interest. With a Roth, you can sit back and watch your investments grow over the years without having to worry about tax payments once you're ready to retire.

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