Roth IRA is a type of individual retirement account that has unique tax advantages. With a Roth IRA, you make contributions with after-tax income and if withdrawn under allowed circumstances, you won’t pay taxes on any earnings. Because a Roth IRA is such a valuable retirement savings tool, let’s take a look at how you can maximize the returns on your contributions.
- There are many options when it comes to investing your contributions in a Roth IRA.
- The investments you choose for your contributions are what will determine your rate of return.
- The investments you choose will likely depend on your age, when you want to retire, and your risk level.
What Is the Average Return on a Roth IRA?
Because a Roth IRA is an investment vehicle, rates of return vary based on the types of investments you have, according to Raya Reaves, a finance coach and founder of City Girl Savings.
Different investment types yield different returns. For example, investments in stocks historically have higher rates of return (averaging 10% per year). Investments in bonds have historically lower but less risky rates of return (averaging 5% per year).
How Roth IRA Rates Work
You can open a Roth IRA through a bank, stockbroker, mutual fund provider, life insurance company, or another type of financial institution that offers this style of investment account. Through a Roth IRA you can invest your contributions in stocks, mutual funds, exchange-traded funds or other investment vehicles.
Your investments grow as the market grows, but your investments can also shrink if the market experiences a downturn. Because people contribute to Roth IRAs over many decades, the goal is to experience enough growth to balance out any downturns.
When you contribute to a Roth IRA, you do so with earnings you’ve already paid taxes on and you don’t pay taxes on the earnings when you distribute them as long as you meet distribution guidelines.
According to Shari Greco Reiches, wealth manager, behavioral finance expert, and author of “Maximize Your Return on Life: Invest Your Time and Money in What You Value Most," the rate of return is based on the investments you choose.
“If the participant has a long time horizon, the Roth IRA tends to be allocated on the more aggressive side since the earnings grow tax-free,” Greco Reiches said.
Your rate of return will be affected by your investments, which you will likely pick based on your age and risk level. When you’re young and starting out in your career, you’re more likely to choose riskier investments with a higher potential return, as you have time to bounce back if they don’t perform well. If you are nearing retirement, you’ll want to switch to safer investments even if they aren’t as likely to generate significant growth.
Let’s look at how a rate of return of 6% can help your retirement contributions grow over the years. If you contribute $6,000 (the annual contribution limit for those under the age of 50) and have an average annual return of 6% for 20 years, you’ll end up with $233,956 in your Roth IRA even though you only contributed $120,000.
Contributing to a Roth IRA can help you save money on taxes and is an especially helpful tool for those whose careers are young and still in a lower income tax bracket, as there are income limits surrounding who can contribute to a Roth IRA.
Investment Options With a Roth IRA
There are many options for how you can invest your contributions in a Roth IRA. While there is no guaranteed rate of return for most investments, Reaves explained the types of returns you can generally expect to find with the following popular investment choices:
- Stocks: 10% rate of return
- Bonds: 5% rate of return
- Stable market value funds: 3% rate of return
Remember, if you keep your contributions in your Roth IRA as cash, they won’t have a chance to grow at all.
When you open a Roth IRA and choose investments for your contributions, here are a few things to keep in mind.
- Brokerage fees. You may be charged a fee to open or manage your account. In some cases, you may even be charged a fee for every trade you make. Confirm all fees you can expect to run into before you open your account.
- Minimum balance requirements. Some brokerages require you to make a minimum initial contribution, and you may be expected to maintain a minimum balance at all times.
- Account style. If you prefer to manage your investments yourself, a robo advisor may suit your needs, or you can opt for professional human help. Make sure you choose a brokerage that offers the style of account management you prefer.
Deciding on Your Roth Investment Strategy
You’ll need to come up with your own unique investment strategies to fit your savings goals and lifestyle, but Reaves walked us through some popular ones.
“If you’re a younger individual, a portfolio with mostly stock investments will better serve you— you have more time to ride the waves of the market and generate that historically 10% return. Consider investments that generate higher returns over time and include companies you feel have long-term staying power,” Reaves said.
When it comes time to invest in a Roth IRA, it’s important to think strategically about your unique timeframe, risk levels, and growth objectives.
Reaves went on to explain that if you’re very conservative or are closer to retirement, then less volatile investments like bonds are a better option.
"Since bonds and stable value funds aren’t as risky as stock investments, your return won’t be as high. On the other hand, you’re less likely to lose money with these types of investments. The less time you have in the market, the less risky you want to be with how your money is invested,” Reaves said.
Frequently Asked Questions (FAQs)
Who offers the best Roth IRA rates?
How do you set up a Roth IRA?
You can open a Roth IRA at a variety of financial institutions. To set up an account, you’ll follow the unique account opening process that the institution has and then will make an initial deposit or recurring transaction in order to contribute to your account. Once you’ve contributed, you’ll need to make investment choices for your contributions.
Who can contribute to a Roth IRA?
In order to contribute to a Roth IRA, you have to meet certain earning requirements and can’t earn more or less than the required amounts. If you earn the right amount, you can make regular contributions no matter how old you are. You can learn more about these income limits here.
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