Why Are Roth IRA Better for Young Adults

There are several different retirement account types, so why is Roth IRA better for young adults? What makes Roth IRA best for certain people? Can older people still benefit from Roth IRA?

Why Are Roth IRA Good?

A Roth IRA is one of several tax-advantaged retirement accounts. Like the traditional IRA, all money deposited in a Roth IRA grows tax-free. There are no capital gains taxes on a Roth IRA and no taxes on dividends or interest earned inside a Roth IRA.

Why Is a Roth IRA Better Than a 401k for Younger People?

What makes a Roth IRA so good is that unlike both traditional IRAs and employer sponsored retirement plans like 401(k)s is that withdrawals from Roth IRA are tax-free. With traditional IRAs or 401k plans, withdrawals are taxable even if you are over 59 1/2. However, you cannot deduct your contributions to a Roth IRA.

Why Do a Roth IRA?

So, what makes a Roth IRA better for younger people? As a younger person, the money you put into a Roth IRA will have much more time to grow. So, all things being equal, a younger person will end up with a higher amount of earnings in their retirement account than an older person might. All of that growth would end up taxable in a traditional IRA or 401k plan. Getting 30 years, or more worth of investment gains and earnings tax-free will be worth much more than a one-time tax deduction when contributing to an IRA.

Does Roth IRA Have RMD?

Traditional IRAs and 401k type accounts require RMD, or Required Minimum Distributions. Once you turn 70 1/2 you have to withdraw a minimum amount from these tax-deferred retirement accounts. That amount is taxable. Roth IRA does not have RMD. Since Roth IRA withdrawals are tax-free, the IRS doesn’t care whether you withdraw the money or not.

Are Roth IRA Good for Older People?

Roth IRAs can still be great for older people. Even someone in their 40s could have 20 or more years of growth until retirement. Many people forget that just because you retire at 65, doesn’t mean you withdraw everything from your IRA on that date. Consider someone in their 50s contributing to a Roth IRA. There will be 15 years of growth before they turn 65. Then, if they live to be 85, they could still be withdrawing from their Roth IRA, giving the funds inside 35 years’ worth of growth, every penny tax-free.

Why Do Roth IRA Have Contribution Limits?

When Congress passed the laws for Roth IRAs, they wanted to make a retirement plan that could help middle- and upper-class people save for retirement without giving the rich a way to stash away a lot of money tax free. There are two limits on Roth IRAs that help keep them from being a giveaway to the rich.

First Roth IRAs have contribution limits. Although the IRA contribution limits change every year, the Roth IRA contribution limit for 2022 is $6,000. If you are age 50 or older, you can contribute an additional $1,000 for a total of a $7,000 Roth IRA contribution.

All IRA contributions for one person are included in the limit, so while you can contribute to both a Roth IRA and a regular IRA, the total contribution to both accounts must be under the $6,000 limit ($7,000 for 50 and older). An example, is Dave contributes $4,000 to his Roth IRA. He can then contribute up to $2,000 to a traditional IRA unless he is over 50 in which case he can contribute $3,000 to a traditional IRA.

Why Do Roth IRA Have Income Limits?

Another way Congress tried to keep rich people from abusing Roth IRAs was to implement income limits on Roth IRAs. While Roth IRA income limits are adjusted every year, the Roth IRA income limits for 2022 are $129,000 for single filers, or $204,000 for married filing joint. Above that, there is a reduced contribution up to $144,000 or $214,000 respectively. You use modified adjusted gross income (MAGI) for IRA contribution limits.

Why Is Roth IRA Income Limit So Low?

To avoid having wealthy people get the benefits of a Roth IRA, and thereby make it impact the budget less, Congress made Roth IRA income limits low enough to keep out higher income people without screening out middle class citizens who earn a high salary for their field.

What Is Backdoor Roth IRA Trick?

There is a way to get a Roth IRA even if you make too much money. A backdoor Roth IRA is when you make contributions to a traditional IRA with no income limits and then convert that account to a Roth IRA account. There used to be an income limit for backdoor Roth IRA conversion, but Congress eliminated that.

backdoor roth ira conversion mega backdoor

To do a backdoor Roth IRA conversion, you must pay taxes on all gains accrued within the traditional IRA. You also must pay taxes on the contributions if they were deductible, but not if they were not deducted.

What Is a Mega Backdoor Roth?

A mega backdoor Roth conversion is just a regular backdoor Roth IRA conversion with a big account balance. Some people just like to sound important

Does It Matter Who You Open a Roth IRA With?

It matters who you open a Roth IRA with. Some brokerages have a minimum opening balance. Roth IRAs with banks are bad when they only offer the ability to earn a low savings rate interest. If you already have a brokerage firm that you are happy with, contact them about opening a Roth IRA. Think twice about paying annual IRA account fees. Many places have free Roth IRAs. If you don’t have a lot of money to invest, consider using one of the microbrokerages like Stash or Robinhood or Wealthfront that allow you to invest with small amounts of money.

As of this writing Fidelity and Charles Schwab offer free Roth IRA accounts and free trades on many stocks and ETFs.

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