One of the best things you can do to build wealth for the future is contribute to a tax-advantaged retirement account. These accounts, including 401(k)s and individual retirement accounts (IRAs) provide you a way to receive a tax benefit while you build a nest egg for your future.
If you want to set aside money and don’t have access to a 401(k) — or if you want to save in addition to your 401(k) — you can use an IRA. One type of IRA with a specific set of benefits is the Roth IRA. Here’s how to start a Roth IRA, and how to decide whether it’s the right move for you.
What is a Roth IRA?
So what is an IRA? An IRA is an individual retirement account. Basically, it’s a way for you to set money aside for retirement, individually, without the need for an employer-sponsored retirement plan.
A Roth IRA is a specific type of retirement account that focuses on helping you grow your wealth over time. There are different IRA types, including a traditional IRA. There are also IRAs for businesses, like a SEP IRA or a SIMPLE IRA.
While both Roth IRAs and traditional IRAs can offer tax benefits, the tax treatment of contributions differs between the two.
- A traditional IRA is tax-deferred. You make contributions with pre-tax dollars. What you put into a traditional IRA reduces your taxable income, giving you a tax break today. Later, when you withdraw money from your traditional IRA, you pay taxes on it at your regular rate.
- A Roth IRA grows money tax-free. However, the reason a Roth IRA grows tax-free is that you make contributions with after-tax dollars. You won’t get a tax break today, but the money in your Roth IRA investment account could potentially grow over time, and when you withdraw the funds, you won’t have to pay taxes on them.
Roth IRAs also come with a few other benefits, including the ability to withdraw original contributions without penalty and no required minimum distributions when you reach age 72. With a traditional IRA, you'll pay an early withdrawal penalty if you take money out of your retirement account before age 59 ½, and you're required to take minimum distributions once you turn 72.
It’s important to note, however, that you have to meet certain requirements in order to contribute to a Roth IRA. Each year the IRS sets an income limit, so you can’t contribute if your modified adjusted gross income (MAGI) exceeds a certain amount of money. Additionally, there is a limit to how much you can contribute, combined, to Roth and traditional IRAs. That contribution limit changes each year, based on IRS calculations and guidance, so be aware of that before making contributions.
How to open a Roth IRA
When you’re ready to figure out how to start a Roth IRA and begin saving for retirement, you can take the following steps to move forward.
1. Talk with your financial advisor
If you have a financial advisor, they may be able to offer assistance with or advice about how to start a Roth IRA. Your financial advisor can also help you figure out if, with your current situation and your future financial goals, a Roth is the right tax move for you. A good financial advisor can also help you figure out which assets are best kept in a Roth, and which might be better in other investment accounts.
2. Research the requirements
Before you open a Roth IRA, it’s important to understand the requirements. For 2021, your ability to contribute to a Roth IRA begins phasing out when your MAGI exceeds $125,000 as a single filer. For married couples filing jointly, contribution restrictions are based on whether you or your spouse is covered by a workplace retirement plan, and other items. The phaseout for 2021 begins when your total MAGI as a married couple exceeds $198,000. Check with a financial professional or review your workplace situation before deciding to contribute to a Roth IRA.
3. Determine what you’d like to invest in
Before adding assets to your Roth IRA, research the market, consider your risk level, and think about your investment options. If you want to invest in stocks and bonds or use mutual funds or exchange-traded funds (ETFs), you might choose to open a brokerage account. However, if you decide to hold other types of assets in your Roth IRA, including real estate, some precious metals, or even businesses, you might need to talk to a special type of custodian and open a self-directed IRA.
If you’re keeping your Roth IRA pretty simple, you can use a robo-advisor. The best robo-advisors help you figure out a portfolio allocation based on the info you share about risk tolerance, time horizon until retirement, and other factors that can influence your returns.
4. Find the right investment platform
Think about what’s important to you and do your research before you open an account. Finding the right investment platform for you is important. For instance, if you want to keep things simple, you might want to open a Roth IRA with a robo-advisor, which allows you to get started by answering a few simple questions about your risk tolerance and goals. Your portfolio will be automatically rebalanced based on an algorithm.
On the other hand, brokerage firms and financial advisors can help you set up a Roth IRA that is more tailored and fits in with your overall long-term goals. You can also opt for a self-directed IRA to have complete control over your IRA and its asset allocation. However, there might be additional regulatory requirements when you use a self-directed IRA, so it’s important to do your research.
If you’re looking for the right investment platform, check out our picks for the best brokerage accounts.
5. Figure out your contributions
If you have a financial advisor, they can help you decide how much to set aside each month. If you don’t, you can still determine how much to invest each month on your own. Start by looking at your budget and priorities to decide how much you can put into your Roth IRA. You can also use a compound interest calculator to estimate how your money might grow over time and determine how much you need to put in if you want to reach your goals for your nest egg.
6. Open your account
In many cases, opening a Roth IRA is pretty straightforward and can be done in minutes. The last time I opened a Roth IRA, I needed:
- State-issued photo identification, like a driver’s license or passport
- Social Security number
- Name and address of your employer
You may also need to answer questions about whether you work in the securities industry. Depending on the situation, you might also need to be prepared to name a beneficiary who will inherit your account if you die. You’ll need the name, address, and Social Security number for your beneficiary. For married couples, this might be a spouse. I chose my son as my beneficiary.
Finally, you need to fund your IRA. Have your bank or credit union’s routing number and your bank account number handy so you can easily set up your contributions.
What to do once you’ve opened your Roth IRA
Once you’ve opened your Roth IRA, you need to take some important steps in order to grow your wealth and work toward your nest egg goals.
Make consistent contributions
When you set up your Roth IRA, you want to create a regular contribution plan so you have a nest egg when you reach retirement age. One of the biggest retirement mistakes is not making regular contributions. Even if it’s only a few dollars a week, consistent investing could help you grow your wealth. Most IRA custodians allow you to set up recurring contributions from your checking account. Your employer might even arrange for Roth IRA contributions to come out of your paycheck.
Rebalance your portfolio
As you set up your Roth IRA, you likely have a balance of stock and bond investments (sometimes as mutual funds or ETFs), as well as cash. You might have other assets, depending on your investment choices. Chances are you have a specific asset allocation target based on your goals and timeline. Over time, your asset allocation can get out of balance as some things do better than others. Rebalancing is a way to sell some better-performing assets and use the proceeds to buy more of something that isn’t doing as well.
Depending on the situation, you might decide to rebalance when your asset allocation gets more than 4% to 5% out of range for your goals. You might also decide to shift your portfolio as you approach retirement, changing your asset allocation to reflect your changing needs. If you opt for a robo-advisor, your portfolio will be rebalanced automatically, based on the algorithm that assesses performance and goals.
Check your portfolio regularly
Review your investment performance. Realize, though, that when investing for the long term, you’re going to go through multiple down markets. During those times, your portfolio’s performance might be disappointing, but over time, it is likely to smooth out. However, it can make sense to check your retirement savings account balance each quarter, just to see if you’re on track and decide whether you need to rebalance. You may want to check it more or less often, depending on your preferences.
Work toward maximizing your contributions
For tax year 2021, you can contribute up to $6,000 to a Roth IRA. So if you aren’t putting at least $500 a month into your IRA, consider working toward increasing your contributions. You don’t have to do it overnight, but it’s wise to free up more money in your budget to put toward your Roth IRA. Over time, you can increase your regular contributions until you eventually reach the maximum contribution each year.
Note that you can contribute an extra $1,000 per year once you reach age 50. This catch-up contribution can help you put more away toward retirement.
FAQS about how to start a Roth IRA
How much money do you need to start a Roth IRA?
Some investment platforms will let you open a Roth IRA without any money at all. However, others may require a minimum contribution. Perhaps you need to contribute a set amount each month or have a minimum amount to open an account. Research the platforms before you open an account.
Where should you open a Roth IRA?
The best place to open a Roth IRA is with a platform that meets your needs. Several brokers offer these accounts and can help you figure out the best way to move forward. Vanguard and Fidelity are some of the more traditional financial institutions that offer Roth IRAs. However, there are also robo-advisors like Betterment and Acorns that offer Roth retirement accounts.
Figure out what you’re looking for in a platform, and then open an account with a broker that meets your needs and preferences.
What is a good age to start a Roth IRA?
You can open a Roth IRA as soon as you have earned income. Indeed, some believe that it makes sense to start a Roth IRA when you’re younger and you pay less in income taxes. Because you make contributions with after-tax money, if you have low income taxes today, it can make sense to pay your taxes at a lower rate, and then take advantage of the tax-free investment growth in your Roth IRA account.
It’s even possible for minors to have a Roth IRA. In fact, I opened a Roth IRA for my son when he was younger so he could make contributions at a young age. If you have a child who is earning income through a summer job or some other means, consider opening a custodial Roth IRA on their behalf.
Can you lose money in a Roth IRA?
Because a Roth IRA is a retirement investment account, it’s possible to lose the money you put in. However, it’s also worth noting that, over time, investments may gain value. You may be able to reduce your exposure to market volatility by investing in an index mutual fund or ETF that is exposed to a wide swath of the market.
The bottom line
If you’re learning how to invest money, using a tax-advantaged retirement fund can help you grow your wealth more efficiently over time. Once you learn how to start a Roth IRA, you can then open one and take advantage of the ability to grow your wealth for retirement.
There are some requirements with a Roth IRA, however, so it’s important to review your eligibility before moving forward. If you don’t meet the criteria for a Roth IRA, you might be able to open a traditional IRA or another type of retirement account. If you have questions about which option is right for you, consider working with a financial planner to decide what makes the most sense for your situation.