How to Maximize Your Returns When Investing in a Roth IRA

An Individual Retirement Account (IRA) is a tax-advantaged retirement plan that enables individuals to save for retirement and build a substantial corpus for themselves. An IRA can be opened at a bank, a life insurance company, a mutual fund house, a credit union, or by a broker. There are primarily two kinds of IRAs – a Traditional and a Roth. The major difference between the two is that withdrawals from the former are taxed as ordinary income in retirement whereas withdrawals from the latter are not taxable in retirement provided you adhere to certain rules mandated by the Internal Revenue Service (IRS). In a traditional IRA, you make tax-deductible contributions which is why you have to pay tax on your withdrawals in retirement. Conversely, in a Roth IRA, you make contributions from your after-tax dollars due to which your withdrawals are tax-free in retirement.

A Roth IRA is a popular investment instrument that you can use to boost your retirement savings. However, to do so effectively, you need to first understand its rules and the different ways it can help maximize your returns. For example, you must be 59.5 years of age and must have held your account for at least five years before you can make a tax-free withdrawal from your Roth IRA. Moreover, the IRS revises the Roth IRA contribution limits every year or so. Reach out to a professional financial advisor who can help you understand the different rules with respect to contribution limits, withdrawals, and more.

For 2022, the Roth IRA contribution limits as per your filing status is as follows:

	Filing status	Modified Adjusted Gross Income (MAGI)	Maximum annual contribution
1	Single, head of household, or married taxpayers filing separately	Less than $129,000	$6,000 or $7,000 if 50 or older
		$129,000 up to $144,000	Contribution is reduced
		$144,000 or more	No contribution allowed
2	Married taxpayers filing jointly or qualifying widow(er)	Less than $204,000	$6,000 or $7,000 if 50 or older
		$204,000 up to $214,000	Contribution is reduced
		$214,000 or more	No contribution allowed
3	Married taxpayers filing separately	Less than $10,000	Contribution is reduced
		$10,000 or more	No contribution allowed

 

For 2022, you can make a maximum contribution of $6,000 each year to your Roth IRA account. However, if you are 50 or up, you can make a catch-up contribution of $1,000 bringing your total contribution to $7,000 for the year.

If you wish to maximize the potential of your Roth IRA, consider the below strategies:

1. Max out your Roth IRA contributions:

As of 2022, you can contribute up to $6,000 annually to your Roth IRA account. Now, this may not seem much but suppose you save $6,000 every year for ten years, you would have saved at least $60,000 over this period. Once you add the return on your investment and take into account the power of compounding, your account’s value will be much, much higher. Doing so consistently will help you stay focused and ensure that you stay on track to reaching your savings goals. Taking the aforesaid example a little further, an investment of $6,000 a year for 30 years means you will have saved a sum of $180,000. This amount will keep on growing year on year with the help of compound interest allowing you to have a financially secure retirement. Maximizing your contributions can go a long way toward reaching your financial goals in time. If you cannot contribute up to the maximum contribution limit, try to contribute at least 50% of it and aim to increase your contribution gradually to 75% and ultimately the full investment amount. No matter how much you earn, try to contribute the maximum you can.

2. Choose the right investment options:

You can invest in a number of instruments such as mutual funds, money market funds, exchange-traded funds (ETFs), stocks, bonds, certificates of deposits (CDs), and even cryptocurrencies through your Roth IRA account. Your returns will majorly depend on the investment options you choose so you have to be careful while choosing the investments. Ensure that you compare the returns, past performance, and growth potential of the instruments you are thinking of investing in. In addition, you must also take into account the fees or costs of investment and your risk tolerance. Suppose you have a high-risk tolerance, you may choose to invest in stocks more. But if you wish to balance out the risk, you may consider investing in mutual funds or bonds. Doing so will help distribute the risk and secure your money against market volatility. That said, try not to pick the same investments that you have invested in your investment portfolio outside of the Roth IRA. For example, if you own an FMCG company’s stocks outside your Roth IRA, try to pick stocks belonging to other sectors and companies for your Roth account. This will allow you to build a diversified portfolio with a greater potential to earn money. Doing so would also help you minimize risk and allow you to capitalize on different market opportunities. Take professional help from a financial advisor if needed so that you can make an informed decision.

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3. Select the right plan administrator for your Roth IRA account:

As stated before, you can open a Roth IRA account in a number of places - a bank, a life insurance company, a mutual fund house, a credit union, or by a broker. The entity you choose to open your Roth account depends on your risk tolerance, investment budget, and financial needs and goals. For example, if you pick a credit union or life insurance company, they may offer you low-risk investment instruments such as bonds, CDs, money market accounts, etc. These investments offer low-risk returns and are considered to be ideal investments for individuals nearing retirement or who may retire in the coming five years or so. You can also go this way if you have recently switched to a Roth IRA and may retire in the near future. However, if you are years away from retirement, going for a mutual fund house or a broker would be more beneficial in the long run. You can invest in high-risk investments such as equity through brokers and mutual fund houses that can help you grow your money and save for retirement. This can also prove useful if you are planning to use your Roth IRA to pay for a child’s college tuition. 

4. Take the Roth IRA rules into consideration:

To derive maximum benefit from your Roth IRA, you must adhere to the rules. Its primary benefit is the ability to make tax-free withdrawals in retirement. To do so, you must be 59.5 years of age. If you make a withdrawal before reaching the said age, the IRS will levy a 10% penalty on the withdrawn amount. In addition, you must also fulfill the five-year rule. This rule states that you must withdraw your money after at least five years of holding your Roth IRA account. This rule is also applicable to Roth conversions. For example, suppose you held your traditional IRA account for 25 years and subsequently decided to switch to a Roth IRA. Herein, you would have to wait five years from the date of conversion to make a tax and penalty-free withdrawal in retirement. If you adhere to the rules, you will ensure that you don’t lose your hard-earned money. That said, there are a few exceptions to Roth IRA penalty rules. These are:

• If you are buying a home for the first time.
• If you are paying for the college tuition of your children
• If you are adopting a child or having a baby.

To conclude

Planning for retirement is a critical part of securing your financial future. By adding a Roth IRA to your investment portfolio, you can benefit from tax savings, make tax-free distributions in retirement and even pass on your account to a beneficiary. To utilize a Roth IRA to its fullest extent, you must understand and follow its rules. Take care to be up to date with its contribution limits and be aware of the penalties and withdrawal limitations, etc. Also, ensure that you select the right investment to make the most of your Roth IRA.

Reach out to a professional financial advisor who can assist you when it comes to opening or managing your Roth IRA. Use the free advisor match service to connect with 1-3 financial advisors based on your financial requirements. All you need to do is answer a few simple questions about yourself and the match tool will find advisors that match your financial needs.