Once you’ve established your emergency fund, it’s time to continue to pay yourself first but for a sunny day in the future – your retirement. For most people (this includes you) the Roth IRA is going to be a great option to save money for retirement and have a tax-free source of income once they hit their golden years. The Roth IRA was named after its namesake, Senator William Roth of Delaware. The IRA part simply means Individual Retirement Arrangement.
Roth IRAs work like this: You save money into your Roth IRA on an after-tax basis. What this means is that when you get paid from your job and you’ve already paid Uncle Sam his share in taxes – you get what’s left over. Of those leftovers (couldn’t help the food reference) you can take some of that money and put it into a Roth IRA. This money then goes into an account of your choosing. This could be into mutual funds, stocks, bonds, ETFs, or even a simple savings account at your bank. There are a few things that are not allowed in IRAs such as life insurance and collectibles like art and antiques.
Over time your contributions, depending on how they’re invested, will grow tax-deferred into a nice little nest egg ready for you to hatch at retirement. The magic of the Roth IRA really begins here. Remember when I said that after-tax money was going into the account? Well, since you’ve gone through the pain of having been taxed on that money already, any qualified withdrawals from your Roth IRA are now…wait for it…TAX FREE! Imagine an income source in retirement that cannot be taxed.
There are some great calculators online that can be used to show you how much you can have saved in 10, 20 or 30 years. I’ve included some websites you can visit at the end of the book.
As of this writing in 2013 you are allowed to contribute $5,500 annually to your Roth IRA and if you’re age 50 or older, another $1,000 as a “catch-up” contribution. These numbers will generally increase periodically as inflation increases and as time goes on.
To see if a Roth IRA is an option for you to consider, talk with your financial professional and explore your options. Some good rules of thumb when looking at your options for funding a Roth IRA are to avoid mutual funds with high fees and expenses, insurance products (annuities) with high fees and surrender charges and complex products that are difficult for you (and your advisor) to understand and explain.