How to Use a Roth IRA to Become a Millionaire
As a financial educator, I've observed numerous students grappling with their finances, primarily because they lacked a basic financial education rather than being inherently "bad at money."
I’ve watched women wait a year to set-up a Roth IRA because they were intimidated by the process…only to be heartbroken when they realized it takes 5 minutes to open and that they’ve wasted time they could have been using to build wealth.
Investing can seem daunting due to unfamiliar financial jargon and a lack of knowledge. I'm here to demystify the process and show you how straightforward it can be, especially through instruments like the Roth IRA.
Why You Should Consider a Roth IRA
A Roth IRA is a powerful tool for saving for retirement, allowing you to invest after-tax dollars in various assets like stocks, bonds, and index funds. The beauty of a Roth IRA lies in its tax-free growth and that in retirement you won't owe taxes on withdrawals, unlike traditional IRAs. This feature makes Roth IRAs a great wealth building tool, for W2 employees and entrepreneurs alike.
Eligibility and Contributions
Anyone with earned income is eligible to contribute to a Roth IRA, making it an excellent option for even teenagers with part-time jobs to begin securing their financial future early. For 2024, the contribution limits are $7,000 for individuals under 50, and $8,000 for those 50 and older, subject to income limits which can be found here.
Your tax-filing status and modified adjusted gross income, or MAGI, determine how much money – if any – you can put into a Roth IRA.
If your MAGI is less than$146,000 in 2024 and you're a single filer (or less than $230,000 for those married filing jointly), you can contribute the full amount.
If your MAGI is between $146,000 and $161,000 as a single filer, or between $230,000 and $240,000 if you're married filing jointly, your contribution is reduced. If your MAGI is higher than $161,000 for single filers or higher than $240,000 for those married filing jointly, you are not eligible to contribute directly.
For those whose incomes exceed these limits, a "backdoor" Roth IRA provides an alternative strategy. This involves making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA, bypassing the income restrictions on direct Roth IRA contributions.
This strategy can be beneficial for high earners who wish to enjoy the tax-free growth and withdrawals offered by Roth IRAs but is certainly something you should consult an accountant first before doing as there are certain situations where you could end up with a big tax obligation. Be sure to consult a professional and learn the rules around this before executing.
Steps to Start Investing in a Roth IRA
Choosing a Brokerage: Start by selecting a brokerage firm like Vanguard, Fidelity, or Charles Schwab.
Opening an Account: Provide necessary details such as your name, address, and social security number to open your account.
Selecting Investments: Consider your risk tolerance and goals when choosing investments, with low-cost index funds being a prudent choice for many.
Setting up Contributions: Establish automatic monthly contributions to harness the power of compounding and make life easy on yourself by automating your investing.
Evaluate Over Time: As your life changes you might find ways to increase your contributions or contribute to other tax advantaged accounts. A Roth IRA is a great place to start but it’s not the only tax advantaged way to invest.
Investment Choices within a Roth IRA
Investing doesn't have to be complicated. Low-cost index funds are a great way to get a diversified portfolio at a minimal expense, perfect for long-term growth. Index funds are basically like the variety back of investing. These funds buy a broad mix of stocks or bonds, spreading risk and reducing the impact of market volatility.
Bonds are equally important as stocks in any investment strategy, adding stability and lowering risk across your portfolio. By mixing bonds with index funds, you can maintain a balanced and stable investment approach.
If you're new to investing, consider learning how to create your own simple investment portfolio. It's possible to build a simple, effective buy-and-hold portfolio with just a few funds. This hands-on approach not only saves you money in management fees but also gives you control over your financial future.
Where to Open Your Roth IRA
Several reputable brokerage firms offer Roth IRAs, including Vanguard, Fidelity, Charles Schwab, TD Ameritrade, and E*TRADE. Consider each firm's fees, investment options, and customer service when making your choice.
Potential Growth and Becoming a Millionaire
By investing consistently in a Roth IRA, you can significantly grow your money.
For instance, starting early and investing $500 a month for 30 years and estimated an 8% return on your money (the historical average return of the stock market minus inflation could lead to a sizeable increase in how much you have invested for retirement - in this scenario you’d have ~$680,000 after 30 years of consistent investing.
Conclusion
Investing in a Roth IRA is a viable pathway to building substantial long-term wealth and achieving financial independence. It's accessible to anyone willing to start small and invest regularly. To kickstart your journey towards financial freedom, check out the Journey to Financial Independence - 3 Day Mini Video Course and get free access for 7 days!
