Maxing Out a Roth IRA
My friends in their 20’s don’t think about retirement because they’re either putting money into a Roth IRA or into their 401K plan through work. So, I started wondering if putting money into their Roth IRA would actually work out for them.
What Is a Roth IRA?
A Roth IRA is a retirement plan in the United States that is usually not taxed, as long as some specific conditions are met. The main difference between a regular IRA and a Roth is that the tax break is granted on the money withdrawn from the plan during retirement, instead of when the money is placed into the account.
You won’t want to pull any money out before you retire though to avoid and fees. The only time you may not receive a fee is for a hardship withdrawal. This can include needing to pay for insurance due to losing a job. You will want to make sure to get an insurance you will still be able to pay for if you lose your job. This is just one mistake people make with planning insurance.
Should I Max Out My Roth IRA?
Some may be skeptical about maxing out a Roth IRA since it is possible to lose money in one. Technically, it’s well-known that if you’re planning to retire in your 60’s, you should save around 15% of your income for retirement, so the earlier you start, the easier it’ll be for you in the future. Especially when it comes to selling an old house to invest more money into your Roth IRA.
How much does a Roth IRA grow? For instance, let’s take a 25-year old, making $40,000 a year. In this case, maxing out a Roth IRA will make her be able to save up to $5,500 into a Roth IRA every year, which represents a little under 14% of her annual income. She’ll keep saving $5,500 every year into her Roth until she’s 50. Maxing out a Roth IRA again, she’ll begin contributing $6,500, which is the maximum contribution for people over the age of 50.
How much can a Roth IRA grow in 30 years? Well, considering a 7% annual return in our example, she’ll have around $1.3 million in her Roth IRA when she retires at 65 and she withdraws it from her account, completely tax-free! Starting early is so important that if she had begun at the age of 30, she’d have over $900,000 in her Roth IRA, nearly $400,000 less for just waiting 5 years!
How Much Do I Need in my Roth IRA to Retire?
Despite maxing out a Roth IRA allowed her to obtain an amount of $1,300,000 and that seems like a lot of money, it needs to last for at least 25 years of retirement. Stories of people spending all that money in just a couple of years are very common, so careful planning is needed to make sure this money will last through retirement, and even leave something behind for children or an important charity. It is also important to consider saving money when moving just incase unexpected costs come up.
This is why it is necessary to have a sustainable withdrawal strategy, where you only withdraw what the portfolio can replace. Still considering a return of around 7% a year, an account should grow by 7% a year. Nevertheless, inflation averages 3% a year, leaving a sustainable withdrawal rate of 4% a year, which leaves us with an income of $52,000 a year, adjusted for inflation.
As the example above, $52,000 a year is a great income that can make anyone wish to max out Roth IRA, and this number would be even higher if she were able to continue saving through an additional investment account.
A Roth IRA is Beneficial: When Will You Invest?
At the end of the day, being consistent with your savings and starting early do pay off. You could see in the example how just a couple of years were able to impact the account value and the income. For instance, if she had started 5 years later or retired 5 years earlier, her Roth would be around $900,000, which would result in $36,000 a year in income!
Furthermore, if she had cut off 10 years of investing time she would have around $600,000 in her Roth IRA by the time she retired, leaving her with only $24,000 a year in income, which is less than half of the original amount!
Maxing out a Roth IRA will take time. Therefore, if you start early and save prudently, your Roth IRA will be high enough to afford a modest retirement. If you start saving late or if you’re used to a higher standard of living before you retire, you’ll need to consider saving money through other additional investment accounts.
Remember the Chinese proverb: “the best time to plant a tree was 20 years ago, the second-best time is now.”
