The best exchange-traded funds (ETFs) for your Roth IRA will include funds that are designed for long-term investment. Since ETFs and other investments held in individual retirement accounts (IRAs) grow tax-deferred, certain fund types are ideal for this qualified retirement plan. Learn more about the best ETFs for your Roth IRA.
What Are the Best Types of ETFs for a Roth IRA?
If you are saving for retirement, you probably have more than one investment account. Popular and common account types include IRAs, 401(k)s, and individual or joint brokerage accounts.
Since these accounts receive a different tax treatment, they can each be used for different financial goals. It's important to know which investment types are best for each kind of account.
The best funds for investing in an IRA or a 401(k) are long-term investments, such as stock mutual funds and ETFs. Investments are not taxed while they are held in an IRA or 401(k). That means that if you want to invest in funds that generate taxable income, you should hold them in your IRA or 401(k).
Roth IRAs are a little different. These are funded with after-tax dollars, which means you pay tax on your income before it goes into your Roth account.
Once it's in your Roth account, the money grows tax-free. Any money you take out when you retire will also be tax-free.
Your withdrawals from a Roth IRA may be taxed if the account is less than five years old. You may also have to pay a penalty if you take out any money your Roth has earned before you are age 59½.
Certain types of ETFs are a smart choice for Roth IRAs.
Since IRAs are retirement accounts, you may have years or decades before you need the money. You'll want to get the most benefit from your investments by letting them grow over time.
ETFs that invest in stocks have a lot of growth potential. You may want to choose an ETF that invests primarily in growth stocks for your Roth IRA.
If you want to buy funds that create income, such as dividend ETFs or bond ETFs, an IRA is an ideal account to hold these funds.
Dividends from stocks and interest from bonds can be taxed as ordinary income in a regular brokerage account. If you hold these investments in a Roth IRA, you don't have to pay this tax.
If you have a brokerage account, it's smart to hold tax-efficient funds there. These funds will either produce few dividends or little interest, or income that may be partially or fully exempt from taxes, such as municipal bond interest.
Try to avoid holding high-yield ETFs in a regular brokerage account.
Best ETFs for a Roth IRA
You should have a diverse mix of ETFs in your retirement accounts. There is not one particular type of ETF that should be held only and always in a Roth IRA.
Try to hold a range of ETFs of different types in your retirement account. This is especially important if the IRA is your only long-term savings vehicle. A variety of investments will protect your long-term savings.
Here are specific examples of ETFs that can work well in a Roth IRA or other retirement account.
If a fund has a lower expense ratio, that means you get to keep more of its earnings.
S&P 500 Index ETFs
Funds that passively track the S&P 500 index make good core holdings in Roth IRAs.
Growth Stock ETFs
If you're an investor who doesn't mind some risk if it comes with the chance of higher returns, you may choose a growth stock ETF.
One good choice is Invesco QQQ (QQQ), which invests in most technology stocks in the NASDAQ index. It has an expense ratio of 0.20%.
Another is Vanguard Growth ETF (VUG), which tracks the CRSP US Large Cap Growth Index. Its expense ratio is 0.04%.
Since dividends can be taxed as ordinary income in a taxable brokerage account, it's best to hold them in an IRA.
One of the best dividend ETFs is Vanguard High Dividend Yield ETF (VYM), which tracks the FTSE High Dividend Yield Index. It has an expense ratio of 0.06%.
Another good choice is iShares Core High Dividend Growth (DGRO), which tracks the Morningstar Dividend Growth Index. Its expenses are 0.08%.
As with dividends, interest from bonds and bond funds is taxed as ordinary income. Since investments held in Roth IRAs are not taxed, bond funds can be good ETF investments.
A total bond index ETF like iShares Core U.S. Aggregate Bond (AGG) is a good choice for broad market exposure. Its expenses are 0.04%.
Another good Bond ETF is iShares iBoxx $ High Yield Corporate Bond (HYG). Expenses for HYG are 0.49%.
Keep in mind that when choosing where to invest, you should first pick funds that match your financial goals and your risk tolerance. After that, look at the account type.
Holding a diverse portfolio of ETFs allows you to protect your money and weather changes in the market. In most cases, the tax treatment or investment type is a secondary consideration.
Frequently Asked Questions (FAQs)
How do you open a Roth IRA?
The process of opening a Roth IRA is similar to opening a brokerage account. You'll pick a financial institution where you want to open an IRA, offer basic personal information about yourself, and link an existing bank account to fund your IRA.
When can you withdraw from a Roth IRA?
You can withdraw any amount from your Roth IRA penalty-free as long as you're at least 59 1/2 years old and your first contribution to a Roth IRA was at least five years ago. You can also avoid penalty taxes, regardless of age, if you have a permanent disability or used the withdrawal to buy, build, or repair your first home. The contributions you made to your Roth IRA are after-tax, so they can be withdrawn at any time without incurring a penalty.
How much can I contribute to my Roth IRA?
In 2021, you can contribute up to $6,000 to your Roth IRA, plus a "catch-up" contribution of an additional $1,000, for a total of $7,000, if you're age 50 or older. However, if you earn $125,000 or more per year ($198,000 if married filing jointly), then your contribution limit is reduced as your income increases. Once your annual income hits $140,000 ($208,000 if married filing jointly), then you are no longer eligible to contribute to your Roth IRA. These amounts are adjusted for inflation, so check back for new numbers every year.
How old do you have to be to open a Roth IRA?
Minors cannot open a Roth IRA, so you must be either 18 or 21, depending on the state in which you live. However, anyone who earns income can contribute to a Roth IRA, even if they're a teenager. Teenagers who want to contribute to a Roth IRA need the help of a trusted adult that can open a custodial Roth IRA for them. Once the teenager reaches the proper age, they will gain control of the custodial account and it becomes a normal Roth IRA.
When can I contribute to my Roth IRA for the current tax year?
You can contribute to your Roth IRA under a given tax year's contribution limits until tax day for the year in question. In other words, you can work to hit your 2021 contribution limit at any point before April 15, 2022.
The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.