You’ve probably heard people talk about retirement accounts like they’re some kind of financial magic trick. A Roth IRA is one of those accounts, and it’s actually one of the smartest money moves you can make when you’re young.
- What exactly is a Roth IRA?
- Why it matters more when you’re young
- How to actually open one
- Common mistakes to avoid
What exactly is a Roth IRA?
A Roth IRA is a retirement savings account that lets you invest money you’ve already paid taxes on. The big benefit? When you take the money out in retirement, you don’t pay taxes on any of it. Not on the money you put in, and not on the growth.
Think of it this way: you pay taxes now while you’re probably in a lower tax bracket, then you get to enjoy all that money tax-free later.
How it’s different from other retirement accounts
Most retirement accounts, like a traditional 401(k), work in reverse. You get a tax break now, then pay taxes when you withdraw the money in retirement. With a Roth IRA, you flip that around.
The other big difference is flexibility. You can take out the money you contributed at any time without penalties. The earnings need to stay put until you’re 59½, but knowing you can access your contributions gives you some peace of mind.
Why it matters more when you’re young
Time is your biggest advantage with a Roth IRA. The younger you start, the more your money can grow through compound interest.
The math works in your favor
Let’s say you’re 25 and you put $200 a month into a Roth IRA. If you keep that up until you’re 65, you’d have put in $96,000 of your own money. With average market returns, that could grow to around $500,000 or more. All of that growth comes out tax-free in retirement.
According to the IRS, you can contribute up to $7,000 per year if you’re under 50 (as of 2024). Even if you can’t hit that maximum, starting with whatever you can afford makes a difference.
Your tax rate is probably lower now
If you’re early in your career, you’re likely earning less than you will in 10 or 20 years. That means you’re in a lower tax bracket now. Paying taxes on your contributions today locks in that lower rate forever.
How to actually open one
Opening a Roth IRA is easier than most people think. You can do it through almost any major brokerage or investment company.
Where to open your account
Popular options include:
- Vanguard
- Fidelity
- Charles Schwab
- Betterment or Wealthfront (robo-advisors that handle investments for you)
Most of these platforms have no minimum to open an account and charge very low fees. You can set everything up online in about 15 minutes.
What to invest in
Once your account is open, you need to actually invest the money. Just putting cash in the account doesn’t do anything. The easiest approach for beginners is to choose a target-date fund. These funds automatically adjust your investment mix as you get closer to retirement.
If you want more control, you can pick a mix of stocks and index funds. The SEC offers good guidance on understanding different investment options.
Setting up automatic contributions
The easiest way to stay consistent is to automate it. Set up a monthly transfer from your checking account to your Roth IRA. Even $50 or $100 a month adds up over time.
You can always increase the amount later as your income grows. The habit matters more than the dollar amount when you’re starting out.
Common mistakes to avoid
Not investing the money
This is the biggest mistake. Opening the account is only step one. If you leave the cash sitting there uninvested, it won’t grow. Make sure you actually choose investments.
Forgetting about income limits
Roth IRAs have income limits. If you make too much, you can’t contribute directly. For 2024, the limits start phasing out at $146,000 for single filers. Most people starting out don’t need to worry about this, though.
Taking money out too soon
While you can withdraw your contributions anytime, taking out the earnings before 59½ comes with penalties and taxes. Try to treat this money as truly off-limits unless you have a real emergency. If you need accessible savings, focus on building your emergency fund first.
Waiting to start
The perfect time to start doesn’t exist. You don’t need thousands of dollars saved up. You don’t need to understand every detail about investing. You just need to open the account and start putting money in, even if it’s small amounts.
Frequently Asked Questions
Can I have both a Roth IRA and a 401(k)?
Yes, absolutely. In fact, this is a smart combination if you can manage both. If your employer offers a 401(k) match, contribute enough to get the full match first. Then, if you have extra money to save, put it in your Roth IRA. You get the best of both worlds.
What if I need the money before retirement?
You can withdraw your contributions anytime without penalty. The earnings need to stay in until you’re 59½, with some exceptions for things like buying your first home. This flexibility makes a Roth IRA more accessible than other retirement accounts.
How much should I contribute each month?
Start with whatever fits your budget after you’ve covered your bills and started an emergency fund. Even $25 or $50 a month is better than nothing. The annual limit is $7,000, which breaks down to about $583 a month. Work your way up to higher amounts as your income increases.
Enjoyed this article? Subscribe to our newsletter for more tips delivered straight to your inbox.