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Clearing Up the Confusion Around Roth IRAs
Don't let these common misconceptions keep you from taking advantage of these amazing wealth building tools
A Roth IRA is one of the most powerful wealth building tools that the average person can use to invest and become extremely wealthy.
But there’s so many misconceptions about them which is why so many people don’t take advantage.
Let’s clear up the confusion about Roth IRAs:
First, what is a Roth IRA?
A Roth IRA (short for Individual Retirement Account) is a type of investment account that offers unique tax advantages to help you invest for your future. Unlike a traditional IRA (where contributions are made with pre-tax dollars) a Roth IRA allows you to invest after-tax income.
This means you’d be choosing to pay taxes on your contributions now to avoid having to pay any taxes later on.
The Power of Tax-Free Growth
One of the best incentives of using a Roth IRA is its ability to build you wealth tax-free. As you invest in a variety of assets within your Roth IRA (such as stocks, ETFs, or mutual funds) any earnings and investment gains will grow tax-free over time.
This means you won't owe taxes at all on the growth of your investments when you withdraw the funds in retirement.
Breaking Down the Misconceptions
1) You can't touch any money in a Roth until you're 59.5 years old
While it's true that a Roth IRA is designed for long-term savings, the notion that you can’t access your funds until reaching the age of 59.5 is a common misconception.
Unlike traditional IRAs, Roth IRAs allow for penalty-free withdrawals of your original contributions (not the investment earnings) at any time, regardless of your age.
It's important to understand that your principal contributions can be accessed in case of emergencies or unforeseen circumstances. But I personally would only withdraw funds from my Roth in a desperate situation, as I prefer to keep that money working for me.
2) Roth IRAs are only for retirement
Although Roth IRAs are indeed an excellent tool for retirement planning, they offer greater flexibility than commonly believed. As mentioned above, you can withdraw your original contributions penalty-free before retirement age.
Additionally, Roth IRAs can serve multiple purposes, such as funding higher education or purchasing a first home. First time home-buyers with a Roth are actually eligible to withdraw up to $10,000 with no penalties to help finance their down payment.
These accounts are more versatile than many think and can adapt to your changing financial needs throughout life.
3) You can’t contribute to a Roth IRA if you make too much money
While it's true that there are income limits for contributing directly to a Roth IRA, there is a solution for higher-income individuals who wish to utilize the benefits of Roth IRAs.
If you file taxes single and make $139k+ or jointly and make $218k+ then you can’t directly contribute to a Roth IRA.
Enter the "Backdoor Roth IRA." This method involves contributing to a traditional IRA and then converting it to a Roth IRA. By using this strategy, individuals can still take advantage of the tax-free growth and qualified withdrawals offered by Roth IRAs, regardless of their income level.
4) Anyone with a Traditional IRA can convert it to a Roth IRA
Converting a traditional IRA to a Roth IRA can be a smart move in certain situations, but it's important to note that it may not be suitable for everyone.
There are no penalties for converting a traditional IRA to a Roth IRA, but it does trigger a taxable event. The amount converted is treated as ordinary taxable income and you'll owe taxes on the amount converted in that tax year.
The only outlier to this option is that inherited IRAs cannot be converted.
It's crucial to carefully evaluate your own financial situation, tax implications, and long-term goals before deciding to convert your traditional IRA to a Roth.
5) A Roth IRA is an investment
No. A Roth IRA is just a type of investing account. Not an actual investment.
You still have to pick your investments separately inside of the account for your money to actually grow. (You can choose to invest in stocks, index funds, ETFs, etc.)
As of right now, you can contribute up to $6,500 per year (up from $6,000 in 2022) to a Roth IRA.
Those age 50 or older are eligible for what’s called ‘catch-up contributions’. They’re able to invest up to $7,500 per year (up from $6,500 in 2022).
But there’s a reason they put a cap on the amount you can contribute. The tax-free wealth building potential of Roth IRAs are so powerful that a limit had to be made.
When you invest through a Roth IRA, you’re letting your investments compound (likely for decades) into a huge portfolio meant to help pay you throughout retirement. But the true power of a Roth? All of the gains seen in your investments will be accessible to you TAX FREE!
That’s what makes this account my personal favorite to invest in. Not paying any taxes on future income sounds like a great deal to me!
Hopefully this thread clears up some of the confusion and mystery surrounding these amazing wealth building tools. I hope you now feel more confident in your understanding of Roth IRAs and how to take advantage of them for yourself.
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