My grandma once told me something after retiring that has stuck with me for about a decade now: “Retirement always seems far away until it isn't.” That was her way of telling me it's never too early to begin saving and investing for retirement, and she was absolutely right.
One of the best resources you can utilize for retirement is a Roth IRA, which allows you to contribute after-tax money into the account and take tax-free withdrawals in retirement.
Roth IRAs are especially useful for those who are in relatively low tax brackets now but will benefit more from getting the primary tax benefit of the retirement account later in life when they've retired. If you're able and not taking full advantage of a Roth IRA, you could be doing yourself a disservice. Luckily, there's still time.
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A rare gift from Uncle Sam
The maximum contributions to an IRA for tax year 2022 (what you file this year) is $6,000, or $7,000 if you're 50 or older. The maximums for tax year 2023 (what you'll file in 2024) are $6,500 and $7,500, respectively. Thankfully, you have until Tax Day of the following year to contribute to an IRA. So you have until April 18, 2023, to make your 2022 contributions, and you'll have until April 15, 2024, to make your 2023 contributions.
If you haven't contributed to or maxed out your Roth IRA for the year and have the means, you should definitely consider doing so before this year's Tax Day. Even a seemingly small amount now can pay off big down the road in retirement.
Here's how much one-time investments could be worth in 25 years if you averaged 8% annual returns over that span:
| Investment Amount | Ending Value |
|---|---|
| $6,500 | $44,515 |
| $5,000 | $34,242 |
| $4,000 | $27,393 |
| $3,000 | $20,545 |
| $2,000 | $13,696 |
| $1,000 | $6,848 |
Data source: Author calculations.
By not making a full contribution for the 2022 tax year, you could be shortchanging yourself on much higher gains down the road.
Take advantage while you can
As with most things finance related, there are drawbacks to a Roth IRA, with one of the more notable being the income limit for eligibility. For tax year 2022, if you're single and have a modified adjusted gross income (MAGI) of less than $129,000, you can contribute up to the limit. If you're married and file taxes jointly, you must make less than $204,000 as a couple to contribute the full amount.
Beyond those incomes, the amount you can contribute drops down, and if your MAGI is $144,000 or higher ($214,000 or higher if married and filing jointly), you can't contribute to a Roth IRA at all.
At some point, you may find yourself over the income limit, which is why it's important to take advantage of a Roth IRA while you can. If you're over the income limit and still want to take advantage, you can go a different route, known as a “backdoor Roth IRA.”
To create a backdoor IRA, you contribute to a traditional IRA — which doesn't have any income limits — and then later convert that account to a Roth IRA. There are tax implications, though, so be aware of those before going this route.
It's always best to start as early as possible
The more time you give yourself in investing, the better, thanks to compound earnings. Compound earnings occur when the money you make on your investments begins to make money on itself. You invest, that money (hopefully) makes interest, then that interest makes interest, which in turn makes more interest.
It can be a lucrative, wealth-creating cycle, especially in a Roth IRA. Imagine you invest $6,000 annually inside a Roth IRA and average 8% annual returns over 20 years. In the end, your investments would be worth over $274,500, even though you only personally invested $120,000 over that span.
If those investments were in a regular brokerage account, the roughly $154,500 in capital gains you made would be taxed if you sold your investments. If you fall in the 15% or 20% capital gains tax bracket (which most people do), that's around $23,175 and $30,900 owed, respectively.
You wouldn't owe a single penny if those investments were in a Roth IRA.
Since Roth IRAs allow you to invest in any stock or ETF you could with a brokerage account, it makes sense for most people to contribute and invest in a Roth IRA before making those same investments in a brokerage account. The tax benefits are well worth it.
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