Roth IRA accounts are an opportunity for investors to build wealth now and enjoy tax advantages in the future. Roth IRA accounts are funded with after-tax dollars, and qualified withdrawals from them are tax-free. There are no required minimum distributions (RMDs), so you can continue to add to your Roth IRA account balance as long as you have earned income.
How a Roth IRA Works
A Roth IRA is an individual retirement account that you can open in addition to or inside a workplace retirement plan. Roth IRAs allow investors to contribute money up to an annual contribution limit. These contributions are made using money that has already been taxed, so qualified withdrawals from a Roth IRA are tax-free.
The Best Time to Open and Fund a Roth IRA
Generally, the best time to open a Roth IRA is when you are eligible to do so, based on your income and tax situation, and when you have extra money to save. Here are some other things to consider when deciding to open a retirement Roth account.
You Have Earned Income
The IRS requires that you have compensation or earned income to open a Roth IRA. Acceptable sources of income include:
- wages
- salaries
- freelance earnings
If you have a full-time job that provides a regular paycheck, that will count as earned income. However, you can also qualify for a Roth IRA if you are earning money from side jobs or freelance work that you own.
You Have Met Employer Matching
If you have a 401(k) plan at work, you can open an additional Roth IRA. However, the best time to open a Roth IRA might be after you have met your contributions to your workplace plan for the year and still have money to save. After all, your contributions to the 401(k) plan are deducted from taxable income and reduce your annual tax liability; maximizing your workplace plan can help you receive the full employer contribution if offered.
You Are Young
One of the best reasons to open a Roth IRA when you are young is to benefit from the compounding interest on investments and earnings. Compounding helps grow wealth over time, and the longer you have to save, the better.
Here’s an example of the power of compounding in a Roth IRA. Suppose you opened a Roth IRA at age 25 and contribute $6,000 annually (or $500 monthly) until age 65. Your money earns a 7% annual return over 40 years. You would have nearly $1.3 million for retirement at this savings rate.
But what if you waited until age 35 to open a Roth IRA? In that case, you would end up with about $612,000 saved over 30 years. That’s a significant amount of money you cost yourself by waiting to open a Roth IRA.
Your Income is Lower
Roth IRA accounts allow tax-free withdrawals in retirement. If you expect your income in retirement to be higher than it is now, now might be the right time to open a Roth IRA.
Contributing now may alleviate any concerns about qualifying to contribute to a Roth IRA if your income advances as you progress in your career. Once your income reaches certain thresholds, your ability to save in a Roth IRA will fade. For the year 2022, you cannot contribute to a Roth IRA if your modified adjusted gross income (MAGI) is:
- greater than
- Greater than or equal to $144,000 and you are filing an individual return, head of household, or married filing separately, and did not live with your spouse during the year.
- Greater than or equal to $214,000, and you are a married couple filing jointly, or a qualifying widow(er).
You may also be able to contribute a reduced amount once you reach a certain MAGI threshold. For example, married couples can only make a reduced contribution to a Roth IRA if their MAGI is more than $204,000 and less than $214,000.
Opening a Roth IRA when your income is low may qualify you for a retirement saver’s credit of up to $1,000 for individual filers and $2,000 for married filers. To qualify for 2022, income levels must be very low:
- Head of household: AGI less than $51,000
- Married couples: AGI less than $68,000
Source: https://www.thebalancemoney.com/when-is-the-best-time-to-open-a-roth-ira-5270433
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