How To Invest In A Roth IRA - A Guide To What You Need To Know (2024)

Investing for retirement is always important to keep in mind. If you’ve been thinking about saving for retirement or getting into investing, then there’s a tool that’s a one-stop-shop where you can do both: A Roth IRA.

Since their introduction, Roth IRA’s have become a favorite among savers thanks to the unique design of their tax benefits. Especially among younger savers, they can be game-changer and potentially add thousands of extra dollars to your nest egg when you retire someday.

Here’s what you need to know about Roth IRAs and how you can get started investing in one.

What Is A Roth IRA?

A Roth IRA is a special type of tax-advantaged retirement savings plan approved by the IRS. It’s named after Senator William Roth who first sponsored its creation back in 1997.

A Roth IRA is very similar to a traditional IRA except that the tax benefits are flipped. You pay your taxes on your savings at the time of your contribution, and then don’t pay taxes later on in the future when you retire someday.

That’s different from how a traditional IRA or even a 401(k) plan works. With these types of plans, you don’t pay taxes at the time of your contributions and instead delay them until later on when you withdraw them at retirement.

Those who chose to invest their money into an IRA (either Roth or traditional) cannot exceed $6,000 per year (or $7,000 per year if you’re age 50 and older).

Why Should You Invest In A Roth IRA?

You might be asking yourself: If I don’t get a tax benefit up-front, what’s the point of investing in a Roth IRA?

If you want to achieve financial freedom in retirement, you need to start planning and investing early. There are a lot of good reasons why you’d want to choose a Roth as your preferred retirement savings tool:

1. You get the ability to make tax-free withdrawals when you retire. Because you’ve already paid taxes on the contributions, your savings plus any earnings that you’ve accumulated along the way will be tax-exempt in the future. Considering that most of your nest egg comes from earnings (thanks to the power of compound interest), that’s a huge benefit.
2. Most people make too much money to contribute to a deductible traditional IRA. Though some people would benefit from contributing to a traditional IRA, they can’t because the income threshold is almost half of what’s allowed for a Roth IRA. You can check the income requirements for yourself at the IRS website here.
3. You can access your contributions anytime you want. Generally with most retirement plans, you have to wait until age 59-1/2 until you can start making withdrawals. Otherwise, you have to pay taxes and a 10 percent penalty. However, with a Roth IRA, since you’ve already paid taxes on your contributions, the IRS will allow you to withdraw them as you see fit. You just can’t withdraw any of the earnings until at least age 59-1/2.
4. Roth IRAs do not require RMDs (required minimum distributions). For traditional IRAs and 401(k)’s, once you turn age 72, the IRS forces you to start making withdrawals so that they can start collecting taxes. But since Roth withdrawals are tax-free, RMDs are not necessary.

Where Can You Open A Roth IRA?

It’s very simple to invest in a Roth IRA. Generally, all it takes is going to the financial institution’s website and clicking some type of “Open an IRA” button either on the homepage or from the main menu.

Here’s an example from Fidelity’s website:

As long as you meet the IRS income requirements, you can open one right away and start making contributions.

Here are a few of the most popular places to go to:

Full-Service Or Discount Broker

Any well-known, full-service broker will happily help you to start your Roth IRA. Two very popular options are Vanguard and Fidelity.

If you prefer discount brokers, then you can open one with them too. Try reputable sites such as E-Trade or TD Ameritrade.

One of the advantages of opening your Roth IRA with any of these brokers is that they will have plenty of investment options for you to choose from.

Robo-Advisors

If the idea of investing seems overwhelming, then why not let someone else do all the guess-work for you!

Robo-advisors have been gaining in popularity and are now a very common way for people to start funding their Roth IRA. All you have to do is answer some basic questions about your risk versus reward profile, and the robo-advisor will pick the right funds.

Some of the top choices are services like Betterment, Wealthfront, and M1 Finance.

Banks

Banks (both online and brick-and-mortar) can also be one of the simplest places to open a Roth IRA. Though they may not offer as many options as a broker or robo-advisor, you can take security in knowing that you’re working with a well-known and established institution.

Look to top-rated banks like Ally or Capital One to get started.

What Funds Should You Invest In?

One of the great things about IRAs is that they will often give you more options than your employer-sponsored plan. For the majority of people, they will generally choose to go with any combination of the following types of investments:

• Mutual funds – Collections of investments that may contain any number of assets (domestic stocks, foreign stocks, bonds, commodities, real estate, etc.)
• ETFs (exchange-traded funds) – Similar to mutual funds, but traded in the open market.
• Individual stocks – Shares of companies that are publicly traded in the open market.
• REITs (real estate investment trusts) – Funds that own a variety of real estate holdings. This is a convenient way to invest in real estate without actually owning any property.

Take The Easy Approach

If you want to manage your own portfolio but are unsure of which funds would make the best choices, then do what millions of investors are now doing: Just buy an index fund.

An Index fund is simply a mutual fund or ETF designed to simulate the performance of a popular market benchmark such as the S&P 500 stock market index. Since they were first popularized back in the 1970s, index funds have allowed investors to easily capture the average return of the market without taking on unnecessary risk.

Financial gurus such as J.L. Collins, the blogger and author of the book “The Simple Path to Wealth”, recommends that most investors could greatly simplify how they invest for retirement by purchasing just two index funds:

• Stocks – Vanguard Total Stock Market Index Fund (VTSAX)
• Bonds – Vanguard Total Bond Market Index Fund (VBTLX)

Depending on your tolerance for risk versus reward, you can split the ratio between stocks and bonds to your desired level: 80/20, 60/40, 50/50, etc.