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

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A couple years ago, I participated in a movement, called the #RothIRAMovement, because I believe a Roth IRA is something everyone should know about and utilize to their benefit — especially as a freelance business owner.

You’re responsible for your own retirement, because let’s fact it, the government isn’t going to give you a hand out. I expect that I won’t even receive much Social Security benefits once I hit retirement age (I’m 30 years old right now).

On top of this, you can’t depend on family or friends to take care of you and your business financially, either. So as business owners, the responsibility to save and invest for our future, falls squarely on our own shoulders.

What is a Roth IRA?

A Roth IRA is an individual retirement arrangement (account) that you can control yourself and put money into as you see fit. If you choose to withdraw the funds, they are generally tax free — 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 also 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. Or use the funds as a down payment on your first house, or to pay for higher education expenses. For these reasons, some people like to use their Roth IRA as a back-up emergency fund.

Earnings can be withdrawn tax free, as long as the account has been open for at least 5 years, or you become disabled, reach 59.5 years old, or qualify for another exemption.

How to Get Started and Open an Account

Getting started with a Roth IRA account is actually very easy. Thanks to robo-advisor startups, like Betterment, you can open a free account online in less than 5 minutes, and start contributing as little as $10 per month towards your retirement.

Here’s a step-by-step guide to getting starting with your first Roth IRA.

  1. Get educated and take your time. Take your time understanding the process of an IRA and what it means for your finances. You always want to be comfortable with how/where you invest your money. Then, after you get educated, and more comfortable with investing and building wealth for retirement, you can start investing with other companies for diversification. Local banks, and some online banks, offer less risky IRA options like CD’s.
  2. 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. The only downside is that you will pay a premium for this advice and help.
  3. Use an discount online brokerage account. Many online discount brokerage accounts like Fidelity, Charles Schwab and Scottrade, offer lower fees and more flexibility than a traditional bank or brokerage firm. If you have a basic understanding of DIY investing, and have the time to be more hands on, a discount online broker could be a great choice.
  4. Try a new investment program like Betterment. In November 2012, Betterment.com launched their Roth IRA account, and I jumped at the chance to open a second account. Since that time, I rolled over all of my investment funds (from Edward Jones) into Betterment’s service — and saved myself over $1,000 in advisor fees. Now 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.

 

betterment retirement provider

Investment Options

Depending on your age, personal situation, financial goals, and retirement needs, you may want to have a more or less risky investment approach. Here are the most popular investment options for Roth IRAs.

  • Securities, like stocks and bonds (most risk). 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.
  • Mutual funds (some risk). 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.
  • Certificates of deposits (less risk). 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.

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

IRA 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 a self-employed freelancer now and my income is inconsistent. 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 today.

Try Betterment for Free

 

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About the author: Carrie Smith is the financial artist and owner of Careful Cents, a site that helps creative freelancers overcome financial mountains and make a living on their terms. In May 2013 she quit her full-time accounting job and now works as a full-time business consultant and blogger. She recently launched a new service called, The Client Connection, which matches the best clients with quality freelancers. When she’s not writing about finance, and geeking out over numbers, she enjoys painting, sketching, and making food with her chef husband. You can connect with her in real time on Twitter or Instagram: @carefulcents.

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

  • 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!

  • 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.

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