A Roth IRA is a type of individual retirement account (IRA) that is funded by after tax dollars. This means that your contributions to your Roth IRA are not tax deductible. You can withdraw your contributed money at any time and the money is not taxed again. However, you can only withdraw earnings from your account after the age of 59.5.
Roth IRAs differ from other retirement account plans. The Roth IRA is designed to give a little more freedom such as the ability to keep your account indefinitely. Also, there are no required minimum distributions as seen in 401(k)s and traditional IRAs.
Since Roth IRAs are funded with after tax dollars you do not get a tax deduction like you would in a more traditional IRA that is funded with before tax dollars. However, you also don’t have to pay income tax on Roth IRA withdrawals unlike these traditional IRAs.
Qualifications
Single tax filers cannot contribute to a Roth IRA if their earned yearly income was more than $140,000 in 2021 or $144,000 in 2022. Joint tax filers cannot contribute to a Roth IRA if their combined earned yearly income was more than $208,000 in 2021 or $214,000 in 2022.
Investment Strategy
You can either choose to manage your funds yourself or have it done automatically for you through something called a robo-advisor. Managing your funds yourself entails first funding your account. After funds are in your account you may then enter your Roth IRA and search for individual stocks or mutual funds, exchange traded funds (ETFs), bonds, etc. After you find the security that you want to invest in you then select the number of shares that you would like to purchase. This process is done every time you add funds to your account. You can choose either to purchase more of the securities that you have already purchased, or you can try diversifying your portfolio by purchasing a new security.
Using a robo-advisor is a more hands-off approach to investing. Which can be good for some people who do not want to search and purchase new securities every time they want to invest. Instead robo-advisors are online services offered by some brokerages. The robo-advisor then develops your investment portfolio for you based on the type of investment strategy you deem best for yourself. All you do when using these services is deposit money into your account and the robo-advisor takes it from there diversifying and investing your funds for you and charges a small fee for the convenience.
Determining which of these methods is for you is entirely based on each individual. Some people want to know exactly where every penny of their investments are going and prefer to invest in very specific companies or industries. While others just want to deposit money into the account and see a decent return from year to year. For these people a robo-advisor is definitely better than not investing at all.
Choosing a financial institution
Many different types of financial institutions offer Roth IRAs. Picking one doesn’t have to be a difficult process. Institutions that offer Roth IRAs range from, banks, brokerage companies, federally insured credit unions, and savings/loan associations. Normally brokerage companies are best suited for retail investors. If you already have in mind which securities you would like to invest in then I would do some research into which brokerages offer that security for purchase. Not all companies will allow you to invest in all securities available on the market. If you want to use a robo-advisor I would also suggest doing some research to see if the brokerage company you would like offers that service. Lastly, not all brokerages charge the same amounts. Nowadays you should not be paying for buying or selling shares and the highest percentage fee you should be paying on an ETF or mutual fund is 1%, preferably less.
Open Your Roth IRA
Now that you have picked the financial institution best suited for your investment needs and understand which investment strategy you are going to utilize, you can begin setting up your account through their platform. This varies from institution to institution; however the process should not take longer than 5 minutes or so.
Fund Your Roth IRA
Contributions must be made in cash and not in securities and/or property. The IRS sets contribution limits, and these limits are the same for Roth and traditional IRAs and apply across all IRA accounts you have open. However, it is important to note that you may contribute up to the amount set by the IRS into your Roth IRA while also contributing up to the amount set by the IRS into your traditional IRA. If you have multiple Roth IRAs or multiple traditional IRAs then you can only contribute up to the amount set by the IRS across all IRA accounts that are the same i.e., if you had two traditional IRAs then you could only contribute $3,000 to one and $3,000 to the other, for a total of $6,000 or the amount set by the IRS in any given year.
Choosing Your Investments
After funds are deposited into your IRA (Depending on the brokerage you choose) they can be used to purchase mutual funds, exchange-traded-funds (ETFs), stocks, bonds, CDs, money market funds, and cryptocurrency. The rest it up to you! Research and understand the securities in which you are investing in. Never invest in anything you have not done thorough due diligence on and/or do not completely understand. Investing can be a great way to build wealth over the long term, however it can also be an efficient way to lose money if you do not understand what gives the assets value.
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