You might have heard of a Roth IRA before but didn’t know what it was, when you need to start one or if it even applied to you. You probably thought it was just an old person thing, right? It’s okay, I used to think the same exact thing.
Well here is the reality, it’s not an old person thing and you would be extremely foolish if you didn’t start contributing to a Roth IRA immediately.
You’re probably thinking…whoa Keelan, chill out dude, why are you so passionate about this?
Well to put it simply, the Roth IRA is a HUGELY powerful wealth building tool for millennial teachers.
Here is the simple math.
If you contribute $400 a month to a Roth IRA with an average 7% return from age 20 to age 60, you will have accumulated over 1 million dollars in TAX FREE money over the course of your career. So you just became a millionaire (YES, over 1 million dollars straight into your pocket with no taxes to pay) simply by putting away $100/week.
Are you starting to understand why I am so passionate about this?
A Roth IRA is an amazingly powerful tool for millennials to build wealth and reach financial independence.
As with most long term investing though, it is most powerful when your money has time to grow. So if you haven’t started contributing yet, make sure you get started this week.
In this article I outline some important in’s and out’s about the ROTH IRA, and why it can be so powerful for millennial teachers.
What is an IRA?
There are two types- Roth IRA and Traditional IRA.
The word Roth simply means after-tax. So a Roth IRA is funded with money you already paid taxes on, such as your take home pay from your paycheck.
A traditional IRA is funded with pretax money, money funneled from your paycheck to the account before taxes. Just like a 403b.
Roth or Traditional: Which type of IRA is best for me?
When choosing which type of IRA is best for you, you should ask yourself “Will your tax rate be higher or lower at your time of retirement?”.
If you think it will be higher, than choose a Roth IRA, if you think it will be lower than choose a Traditional.
A Roth IRA is generally best for most millennials because they are in a low tax bracket when opening the account, and will most likely be in a higher tax bracket at the time of retirement.
Why the Roth IRA is SO powerful?
Aside from the fact that you are saving money for retirement, the Roth IRA has some very unique attributes that make it more powerful than other investment accounts.
Here are 4 reasons why the Roth IRA is so powerful.
1. Earnings grow tax-free and withdrawals are not taxed
This is arguably the single most powerful feature of a Roth IRA. Since you pay taxes before contributing, ALL of your growth is tax free.
So if you put in 1K and 30 years later that 1K grows to 30K. You get to keep that entire 30K without paying taxes on it. If your account grows to 1 million, you keep the entire 1 million!
2. Early withdrawals
You can withdraw your contributions (not capital gains) whenever you want with no penalty! This is different from a 403b/401k where you cannot withdraw funds until age 59.5.
Meaning if you contribute $50,000 over the course of 10 years, and you later realize you need some of that money for a house, car, or whatever, you can take out up to $50,000 from your Roth IRA with no penalty. You can basically think of it like a glorified savings account!
It’s important to note that you can only withdraw contributions without penalty. Withdrawing any investment earnings prior to age 59.5 will be subject to a 10% early withdrawal penalty.
3. No required minimum distributions
You are allowed to cash-out on everything within your Roth IRA starting at age 59.5 with no penalty, but it is not mandatory. In fact, there is no age where you have to take it out at all!
Unlike a traditional IRA and other other investment accounts that force you to take withdrawals at a certain age, a Roth IRA can sit and grow for however long you want. Since money compounds to greater amounts the longer you stay in, this can lead to some HUGE returns down the road.
4. Contribute at any age if you have earned income
A Roth IRA can be started at any age as long as you have earned income. Meaning if you are 18 years old and have a summer job, you can start contributing.
This is great for teachers who have yet to land that full time teaching job. So for those that are still subbing or are part time employees, don’t fret if you don’t have access to a 403b yet. The Roth IRA will allow you to start saving for retirement right away.
The Power of Time
I’ve said this multiple times now but it is definitely worth repeating.
Time is your greatest wealth building tool for long term investing.
It all comes down to compound interest.
Instead of giving you an in depth, boring explanation of how compound interest works let me just give you two scenarios.
You start contributing the max of 6,000 to your Roth IRA at 40 years old and contribute to the age of 60. Assuming an average 8% annual return, at age 60 you will have just shy of 300K.
You start contributing half of the max, so 3,000, starting at age 20 years old and contribute to the age of 60. Assuming an average 8% annual return, at 60 you will have 840K.
Not only that, but if you contributed the max of 6,000 a year for 40 years, you would have over 1.6 million by age 60.
Therefore, the more time you spend in the market, the greater your investment will grow.
So start contributing ASAP!
Setting up a Roth IRA
A Roth IRA can be set-up easily through any bank or brokerage firm.
There are a couple of basic eligibility requirements.
1. You must have earned income
So obviously if you are a teacher reading this, you have a job and you meet this requirement. Any type of earned income will work though. So even if you are trying to get your first teaching job and are currently working a side job as a waiter or at a daycare or whatever, that still counts as earned income.
2. You must earn below a certain income
The IRS sets income limits that restrict high earners from contributing to a Roth IRA. For 2020, your MAGI must be below $139,000 if you are single, and $206,000 if married filing jointly. Don’t worry though, there are ways around this if you are a high earner. Check out a backdoor Roth IRA if you ineligible because of your income.
For 2020, the IRA contribution limit is $6,000 for the year.
If you are above the age of 50, you can contribute up to $7,000.
How and when you contribute for the year is up to you. You can contribute a lump sum all at once or you can spread out your contributions over the course of a year. Both methods deliver similar returns.
The Roth IRA is a great wealth building tool for millennial teachers.
Contributing to a Roth IRA alongside a pre-tax retirement account (403b and/or 457b) can help to accelerate your path to Financial Independence.
The tax-free withdrawals alone make the Roth IRA incomparable and powerful amongst other types of investment accounts.
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