It doesn’t work like that #1
the magic of the Roth IRA
This is the first entry in a series about common personal finance misconceptions I’ve heard from friends, relatives, and book club acquaintances. I don’t want to be the person who stops the conversation to tell them, “It doesn’t work like that!” (I’ve tried, and some have not taken it well). But at the same time, I don’t want them making important financial decisions from a place of confusion and sometimes fear. Hopefully, this can help solve both problems.
I don’t want to invest for retirement because what if I need the money? It’s locked away forever!
I’ve heard this sentiment repeated over and over. There are so many things I want to say - you will need the money someday - in retirement! Do you have an emergency fund? How stable is your job? How much do you actually spend? What are your fixed expenses? How much savings and investment do you have currently? Are you expecting an inheritance?
Like so many things, giving a blanket answer is not the answer. Understanding how your money is coming and going and where you stand, all things considered, is the only way to determine what is right for you. So I can’t answer how much you should invest, what you should invest in, or even where you should put your money. (Plus, legally, I’m not allowed to do that. This is and always will be information for educational purposes only.)
Fortunately, in this case, there is a bit of a magic rabbit to cure the fear that retirement money is locked away forever - the Roth IRA. (There are more cures to this for other retirement accounts - the Roth IRA is pretty straightforward, though, and overall, a great type of account for everyone.)
A Roth IRA is a type of Individual Retirement Account. Almost anyone can open and contribute to one. The two main limitations are you have earned income (likely you made money by working a job), and you make under a certain amount ($146,000 for single filers and less than $230,000 for those filing jointly in 2024 to contribute the full amount). As of this year, you can contribute $7,000/year to your account if you are under 50 and $8,000/year if you are over 50.
Once the money is in the account, you can (and probably should) invest it in anything from government bonds (TIPS) to individual stocks of the latest company everyone is talking about. If you earn money on your money - from interest, dividends, or even capital gains by buying and selling - you don’t pay taxes on it (you do in a regular brokerage account).
In addition to never paying taxes on the growth or when you use the money in retirement, what’s magic about the Roth IRA is the many ways you can access the funds in the account if needed or wanted without penalty before retirement. If that’s a good idea is a different conversation.
Here’s how:
Contributions, the money you put in (not the growth), can be withdrawn at any time for any reason. If you put $7,000 in last year and now need it to move, buy a new car, or anything in between, you can get the $7,000 out tax and penalty-free. If you max out the full amount each year, you are looking at tens of thousands of dollars built up quickly in case you ever need it.
You can also access up to $10,000 tax and penalty-free to buy your first home (once in your lifetime). If you become permanently disabled, you can withdraw all the money tax and penalty-free to help fund your life.
You can access the money without a 10% penalty but still pay taxes for things ranging from childbirth to disaster recovery to education expenses. (A good primer here.) This is why the wealthy use Roth IRAs to save money for their children’s education!
Most people aren’t saving enough for their future selves. If you’re not doing so because of fear that you might need the money, consider the Roth IRA.
Is there something you are confused about regarding personal finance? Maybe others are, too! I would love to hear any ideas for topics to cover in future series installments.
I look forward to reading your work!