8 Things Millennials Need to Know About Roth IRAs

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Young people can take advantage of decades of tax-free investment growth.

Saving in a Roth IRA can set you up with tax-free retirement income.

If you’re a millennial and you want to start saving and investing for retirement, consider putting your money in a Roth IRA. A Roth IRA is an individual retirement account that has the potential for tax-free investment growth and withdrawals. Millennials have an opportunity to let the account grow for decades without being taxed. Here’s how young people can make the most of a Roth IRA.

1. Follow the rules. In order to qualify for completely tax-free withdrawals, you need to own the account for five years and start taking distributions after age 59 1/2. If you withdraw the money before meeting those two requirements you will owe income tax on the investment earnings, and they could also be subject to a 10 percent early withdrawal penalty.

2. Pay attention to the contribution limits. Most people are eligible to contribute up to $5,500 to a Roth IRA in 2017. Workers age 50 and older are eligible to make catch-up contributions worth up to an additional $1,000, for a maximum possible contribution of $6,500. It’s important to stick to these contribution limits because there is a 6 percent excise tax on excess contributions. Take care to withdraw the excess contributions before filing your tax return to avoid the penalty.

3. Max out each year. If you start making $5,500 Roth IRA contributions each year at age 25, by the time you are 65 you could potentially accumulate over $950,000, assuming you earn 6 percent annually. And even if you earn a more modest return of 4 percent annually, you would accumulate over $565,000. Since it’s a Roth account, you won’t owe income tax on that money in retirement.

4. Take advantage of your low tax rate. While you are in your 20s there is a good chance you are making less money than you will later on in life. Those with low incomes also pay a lower tax rate. When you make Roth IRA contributions with after-tax dollars, you are paying taxes on that money while you are in a low tax bracket. If you keep the money in the account until retirement, you don’t have to worry about paying a higher tax rate on that money later, even if you have a higher income in retirement.

5. Pick your investments carefully. When you open a Roth IRA you will need to make contributions and purchase investments. Figure out if you are going to purchase stocks, bonds, mutual funds or exchange-traded funds and in what proportions. Keep an eye on expense ratios when selecting investments. It’s best to come up with an investment strategy that you can stick to over the long term.

6. Flexible access if you need the money early. You can withdraw the amount you invested in a Roth IRA without penalties or taxes. For example, if you contributed $5,000 to a Roth IRA over a two-year period and the account value grew to $5,500, you can pull out $5,000 without worrying about taxes or penalties. However, the additional $500 would be subject to a 10 percent early withdrawal penalty and ordinary income taxes if you withdraw the money before age 59 1/2.

7. Distributions are allowed for a first home purchase. It’s difficult to prioritize saving for retirement when you also want to accumulate enough money to make a down payment on a home. But saving in a Roth IRA can allow you to use the money for both purposes. Even though most people think of a Roth IRA as a retirement savings vehicle, it can be used for a first-time home purchase. Roth IRAs allow you to withdraw up to $10,000 for a first home purchase.

8. Make sure you are eligible to contribute. Only those with earned income are eligible to contribute to a Roth IRA, and you can’t deposit more than you earned. For example, if you earned $3,000 in 2017, you would only be able to make up to a $3,000 Roth contribution.

There are also income limits for Roth IRA eligibility. If you are a single tax filer and earn more than $133,000 in 2017, you aren’t eligible to contribute to a Roth IRA. For married couples the income cutoff is $196,000. The amount you are eligible to contribute to a Roth IRA is phased out for individuals with a modified adjusted gross income that exceeds $118,000 and couples bringing in more than $186,000. However, some high earners are able to get around these income limits by making a non-deductible contribution to a traditional IRA and immediately converting to a Roth IRA.

Joe Carbone

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About the Author: Joseph Carbone, Jr.

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Joseph A. Carbone, Jr., is a wealth advisor and partner of Focus Planning Group. Joseph is an accomplished wealth advisor with extensive experience in portfolio management/research, financial planning, employee benefits, client relationship management, and insurance design. Joseph holds a bachelor’s degree in finance from Dowling College and obtained the Certified Financial Planner™, Accredited Investment Fiduciary®, and Accredited Asset Management Specialist℠ Designations.
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