Investing Made Simple: A Beginner’s Guide to a Roth IRA

I’m so excited to be participating in this movement, because I believe a Roth IRA is something everyone should know about and utilize to their benefit.

Over 140 bloggers have agreed to be part of this movement, and you can join in the conversation too, on Twitter. Just use the hashtag #RothIRAMovement.

What is a Roth IRA?

A Roth IRA is an individual retirement arrangement (account) that is generally not taxed, if the guidelines are met. Unlike a Traditional IRA, the money contributed to this account is after-tax income, so you don’t have to pay taxes again when you withdraw the funds.

One of the main reasons a Roth IRA is considered the best retirement vehicle, is because the earnings/interest grow within the account tax free. 

You can withdraw your direct contributions (the money you pay in every year/month) at any time, without paying taxes or penalties. For this reason, some people like to use their Roth IRA as a back-up emergency fund.

Earnings can be withdrawn tax free as well, if you fulfill these two requirements.

  1. The account must be open for at least 5 years
  2. You become disabled, reach 59.5 years old or qualify for another exemption

How to Get Started and Open an Account

Find a local brokerage or bank. I opened my first Roth retirement account in 2005, however, I didn’t start contributing to it until 2009 when I sat down with a local broker at Edward Jones. In my opinion, sitting face to face and talking with a Financial Advisor in person, is the best thing to do if you’re just starting out.

After you get educated and more comfortable with investing and building wealth for retirement, then you can start investing with other companies for diversification. Local banks and some online banks (like ING Direct) offer simple IRA options, like CD’s (more detail below).

Use an discount online brokerage account. Many online discount brokerage accounts like Fidelity, Charles Schwab and Scott Trade, offer lower fees and more flexibility than a traditional bank or brokerage firm. If you’re comfortable being more hands on, these options could be a much better choice.

Try a new investment program like Betterment. Last November, Betterment.com launched their Roth IRA account, and I jumped at the chance to open a second account. I can choose the amount of risk, by adjusting the meter between a preset investment basket of stocks and bonds. Stocks are riskier and bonds are more conservative.

Here’s how I’ve divided my stock options. I prefer to have riskier portfolio, since I’m young and plan to keep my money in there for many years.

Betterment Stock Allocation

Investment Options

Most Risk:

Securities, like stocks and bonds. As mentioned above, stocks and bonds are the traditional route when it comes to investing within a Roth IRA. It took me awhile to understand how it all works, but basically you can choose any type of investment vehicle, which is covered by a Roth IRA blanket. You get the same benefits as a normal investment, without having to pay the capital gains tax on dividends.

Some Risk:

Mutual funds. Investing in individuals stocks on the stock market, is very risky. If you want to get in on the “stock market action” but take less risk, you can invest in mutual funds. In my opinion, good growth stock mutual funds are some of the best, and it’s what I put my money into.

Less Risk:

Certificates of deposits (CD’s). Opening a Roth IRA with a CD comes with the least amount of risk. It’s also great to use, if you invest in other methods and want a little diversification. Of course with less risk, comes less reward and using a Certificate of Deposit won’t create much of a return on your money. Although, this option does let you have more control of your investing and assures a steady, solid rate of return.

Contribution Limitations and Income Rules

If you think the Roth IRA sounds too good to be true, well it kind of is. If you make more than a certain amount of income, your contributions will be limited or even phased out completely.

There are ways around this limitation (like opening a nondeductible Traditional IRA and converting it to a Roth), but this is more advanced and somewhat complicated.

Always be sure to check the eligibility requirements first, so you aren’t penalized for putting in too much. I would suggest finding a tax professional, financial advisor or CPA to help. No matter what amount of income you make, the contribution limit is $5,000 per year, or $6,000 for anyone age 50 or older (for 2012).

Advantages

  • Direct contributions can be withdrawn tax-free at any time
  • A lifetime maximum of $10,000 in earnings can be withdrawn tax-free, when used to buy a principal residence, for a first time home buyer
  • You can invest in a 401(k) at the same time as a Roth IRA
  • For estates subject to higher income taxes, having a Roth IRA can reduce the overall taxes due, since the taxes have already been subtracted
  • There is no RMD (required minimum distribution) rule with a Roth IRA

Disadvantages

  • Contributions to a Roth IRA are not tax deductible
  • Investing in a Roth does not reduce your total Adjusted Gross Income (AGI)
  • If you live in a state with a state tax, you will have to pay taxes on the amount to state as well
  • In the future, Congress may change the rules that currently allow for tax free withdrawals

Building Wealth for Retirement

If you haven’t opened a Roth IRA, now is the best time! The younger you are, the more time you will have to save and build wealth. Even putting in a small amount each month is worth it.

Right now, I’m only contributing $50 per month into my Betterment Roth IRA, since I’m using most of my money to get out of debt. But still, can you imagine how much even $25 a month can add up over the next 30-40 years?

Small changes can make a big impact.

Take action now and join the #RothIRAMovement by opening a Roth IRA!

Photo Credit: Tobyotter

About the author: Carrie Smith is the financial artist and editor behind Careful Cents. She helps creative entrepreneurs make a living with their creations, and reach financial freedom through systems and financial organization. She’s been featured in The Huffington Post, Glamour Magazine, Kiplinger Finance and several other business websites. In May 2013 she quit her full-time accounting job to pursue entrepreneurship and blogging. You can find her on Twitter or Instagram @carefulcents.

11 Comments... Read them below or add one of your own

  • Ryan Hardy March 27, 2012, 9:05 am

    Great post Carrie! Ever since my grandpa started an IRA in my name when I was little, I have been interested in saving for my retirement. The one I have now is also a Roth, because like you, I am young and plan on having my money in there for quite some time.

    • Carrie Smith March 27, 2012, 12:16 pm

      That’s awesome Ryan! I think grandparents/parents should definitely think about opening Roth’s for their kids. That’s a really good idea and useful thing for our future.

  • Young Professional Finances March 27, 2012, 3:24 pm

    Great breakdown! I really like the part about which investments are riskier than others – I’m just starting to learn about this so it really helps.

  • YourFinancesSimplified March 27, 2012, 6:36 pm

    Great job Carrie!  The other benefit of the Roth is if you pass it on when you pass away the person who inherits it has some tax free money!

  • Steve Stewart March 27, 2012, 9:08 pm

    Thanks for sharing your Betterment experience. I’m undecided about how to feel about “auto-pilot” investments, which is weird because I’m more the “buy-and-hold” type of guy. A lazy portfolio that matches the market beats a lot of managed accounts, and that’s how I have my ROTH set up. 

    • Carrie Smith March 28, 2012, 11:04 am

      I actually love the “auto-pilot” investment Betterment offers. But I also have a Roth IRA with Edward Jones, for diversification and a more hands on approach. I’m all about dollar cost averaging and holding investments long-term.

      • Guest June 8, 2012, 7:55 pm

        Carrie, be wary of full-service brokers like Edward Jones. They charge a lot in loads (sales charges to buy a mutual fund), management fees, trades, and they steer you into questionable funds for which Jones gets kickbacks. Given your zeal to save and cut expenses, this might be a topic to investigate more–how to keep more of your savings and give less of it to the financial services industry.

  • SavvyFinancialLatina March 27, 2012, 9:18 pm

    I am glad you are contributing to your ROTH IRA. I plan to as soon as I land my job out of school. 

  • Jessica March 28, 2012, 8:13 am

    Thanks for this post Carrie. I’m so overwhelmed by all the information. I’m beginning to wonder if I should be investing at all given my amount of debt BUT I’m so old (well 37 feels really old) that I feel like I HAVE to be doing more. I’m trying to find the balance of debt repayment, savings and debt repayment with investing.

    • Carrie Smith March 28, 2012, 11:02 am

      I can’t tell you what’s best for your finances, but if I was you this is what I would do. I would contribute at least a little something, $25 or $50 per month if you can. Put all the rest of your energy and money towards paying off debt, then kick your retirement savings into high gear once you’re debt free.

      This is what I’m doing right now. I’m socking away $50 a month into my Roth while putting every extra penny towards my car loan. But my time-frame for becoming debt free might be less than yours, and I’m a little younger. So it’s totally up to you, but I wanted to share my opinion. :) Hopefully it helps!

  • Worksavelive March 28, 2012, 5:56 pm

    Wow, you did a great job Carrie!

    I love the fact that you took it to the next step and talked about HOW to open up a Roth and choose investments. I’m not clever enough to fit all of that into one post.

    I love the 90/10 asset allocation image as well as talking about how risky single stocks are. Buying single stocks is like gambling (almost). You’re pretty much rolling the dice.

Leave a Comment