12 minutes | Oct 20th 2020

Roth IRA Explained - How A Roth IRA Works (simple)

How does a Roth IRA work and do you need one? In this video, we're breaking down the core elements of a Roth IRA so that you can quickly and easily evaluate if opening a Roth IRA is right for you.


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A Roth IRA can be one of the most effective retirement accounts for young people looking to become tax-free millionaires. That's because of the numerous tax advantages that Roth IRAs give investors.


First, it's important to understand that the money you put into your Roth IRA is money that you have already paid taxes on. This is one of the key differences between a Roth IRA vs. Traditional IRA. With a Traditional IRA, you are saving pre-tax money. With a Roth IRA, you are saving post-tax money.


The impact of this is that while with a Traditional IRA you will have to pay taxes when you withdraw your money in retirement, a Roth IRA allows you to make tax-free withdrawals provided you follow the rules (more on those later).


In addition to your money growing tax-free, you'll also be able to access the cash you deposit into this retirement account whenever you like without any penalties. Notice I said the cash you deposit into your Roth IRA. The money you put into your Roth IRA is yours to withdraw whenever you like. The investment growth on the other hand will need to stay in your Roth IRA until requirement or else you'll be subject to some penalties.


Speaking of penalties, let's get into some of the drawbacks of Roth IRAs (because it's not all sunshine and rainbows).


The biggest drawback to investing in a Roth IRA is that your earnings are out of reach until you reach the ripe age of 59.5. Why 59.5? Ask congress. If you try to take your earnings before then, they'll be taxed and potentially subject to an additional 10% penalty. So the money you're putting into your Roth IRA really should be money you're saving for retirement.


Additionally, there are contribution limits to your Roth IRA that are important to keep in mind. As of 2020, individuals can only put up to $6,000 into their Roth IRA (or $7,000 if they are 50+ years old). If you are just getting started with investing, this might not be a big deal. But if you have more than $6,000 to invest, you're going to need to use a different type of account to invest the rest.


The last major drawback to Roth IRA investing is that if you make too much money, you won't be able to invest in this retirement account. In 2020, if you make more than $139,000 per year, you'll be unable to invest in a Roth IRA.


With those Roth IRA pros and cons in mind, you'll be able to truly evaluate if a Roth IRA fits your investing strategy or if you would be better served by one of the many different types of retirement accounts out there.


Happy Investing!


TIMESTAMPS


0:00 INTRO

0:34 Roth IRA Basics

2:05 Benefit #1 Buying Investments

3:09 Benefit #2 Tax-Free Gains

4:37 Benefit #3 Easy Access

6:24 Drawback #1 Withdrawing Earnings

8:04 Drawback #2 Contribution Limits

9:47 Drawback #3 Income Limits

9:38 Takeaways