Roth IRA’s can make you a tax-free millionaire. But only 6.6% of Americans own one. Here’s everything you need to know about the Roth IRA:
What’s a Roth IRA? A Roth IRA is an “Individual Retirement Account.” Unlike a 401(k) where your employer provides it for you, you must open this account yourself. My favorite brokers to open a Roth IRA with are:
- Charles Schwab
How does a Roth IRA work? You contribute money you already paid taxes on. Then you invest the money you contributed. A common misconception is that the Roth IRA is an investment. Not true. It’s the account. And you buy investments WITHIN the account.
What makes the Roth IRA special? Two things. Tax-free growth & Tax-free withdrawals. You can buy and sell stocks in a Roth IRA as you please without getting taxed. And you can withdraw the money you made without paying taxes as well.
Roth IRA Rules:
- There are income limits for high earners
- Tax-free withdrawals occur after age 59 1/2
- Annual contribution limit of $6,500 (in 2023)
- The account must have been open for 5+ years
Rule 1: Roth IRA Income limits
- 2022: Single is $144,000; Married filing jointly is $214,000
- 2023.: Single is $153,000 Married filing jointly is $228,000
If you make more than those amounts, you cannot contribute to a Roth IRA at all.
Exception: Backdoor Roth IRA – When you contribute to a Traditional IRA then convert the money to a Roth IRA.
Rule 2: Tax-Free withdrawals – You can’t withdraw gains tax-free until age 59 1/2. If you withdraw gains before age 59 1/2 you will incur penalties. But you can withdraw CONTRIBUTIONS without any penalty or taxes.
Exception: You can avoid penalties (not taxes) if you withdraw for the following reasons:
- Education expenses
- Birth/Adoption expenses
- Health insurance if unemployed
- Unreimbursed medical expenses
- First-time home purchase ($10k max)
Rule 3: Annual Contribution Limit – Contribution limits for 2022 are $6,000/year. For 2023 it’s $6,500/year. But if you’re age 50 or over, you are allowed to contribute more money to a Roth IRA than the average person. For 2022 you can contribute up to $7,000/year. For 2023 you can contribute up to $7,500/year.
Rule 4: Account age – Your Roth IRA must have been opened for at least 5 years before you can withdraw from it without penalty. This is in addition to the age requirement of 59 1/2 AND includes contributions. But the same exceptions for Rule 2 apply to this one as well.
Should you open a Roth IRA? A good rule of thumb is if you expect your tax bracket to be higher in the future then you should open a Roth IRA. This way you pay taxes now (when your bracket is lower) and no taxes later (when your bracket is higher).
How to become a tax-free millionaire: Invest $500/month in a Roth IRA for 31 years (2022 numbers) or $540/month in a Roth IRA for 30 years (2023 numbers). That’s ~$1.1 million dollars tax-free.
[Source Brennan Schlagbaum (who is also a great follow on Twitter)]
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