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Investing

How Does a Roth IRA Work?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

As you plan your retirement for life after work, you’ll face a multitude of choices. You might have a 401(k) through your job, for example, and if it matches contributions, you should take advantage of it. But if you don’t have that option or you want some extra security, you could open an individual retirement account (IRA).There are a few different types of IRAs, but the two most popular ones are the Traditional IRA and the Roth IRA. The right choice for you depends on many different factors. Here’s the difference between the two popular IRAs and how Roth IRAs can work for you.

How does a Roth IRA work?

Traditional vs. Roth IRA: What’s the Difference?
Traditional IRARoth IRA

Contributions are tax-deductible

Contributions aren’t tax-deductible

Withdrawals in retirement are not tax-deductible

Withdrawals are tax-deductible

Expiration date on contributions at 70 and a half

Can make contributions as long as you’d like

Must start taking money out at 70 and a half

You can withdraw when you want

Roth IRAs are taxed now, not later

The main differentiator between Roth IRAs and Traditional IRAs is how they’re taxed. When you contribute to a Traditional IRA, all your money goes in tax-free. When you make contributions into a Roth IRA, that money is taxed now.

A Traditional IRA is a great option for those who want all their dollars to go toward investing as soon as possible. With Roth IRAs, you have to envision how your finances will look when you retire. Having taxes taken out now means they won’t be taken out again when you eventually make withdrawals. If you’re expecting to earn more money by the time you retire, avoiding the tax penalties later on in life can mean significant savings.

Withdrawals from Roth IRAs are penalty-free

Although putting money into a Roth IRA is taxed, you can take money out tax-free. For Traditional IRA accounts, you get taxed on withdrawals when you’re eligible to make them—which isn’t a problem if you’re earning less money later on in life. If however, you’re hoping to earn more than you did at the beginning of your career, it might make more sense to stick with a Roth IRA.

Having the luxury to withdraw money without getting taxed means more money in your pocket in retirement. If you don’t plan on working in retirement, you’re going to need every dollar you’ve invested.

No limit on contributions based on age

For some people, the older you get, the younger you feel. So if you’re getting older and you’re not interested in retiring anytime soon, you may still be interested in contributing to your IRA. If you’re older than 70 and a half and you have a Traditional IRA, you can’t make contributions because there’s a stopping point.

On the other hand, Roth IRA account holders can continue to make contributions—and withdrawals— as long as they’d like. Keep in mind that you may be penalized if it’s before you turn 59 and a half years old. This applies to both Traditional and Roth IRAs; however, Traditional IRAs force you to start making withdrawals at 70 and a half — even if you don’t want to.

Eligibility might hold you back

If you’re thinking about a Roth IRA, you might want to check your eligibility first. If you make more than $137,000 as a single filer or more than $203,000 filing jointly (2019), you won’t qualify for a Roth IRA. If that’s the case, a Traditional IRA might work best for you. If, however, you’re below the threshold and want to get every dollar you can out of retirement, a Roth IRA might be the route to take.

Converting Traditional IRAs to Roth IRAs

You can convert to a Roth IRA if you don’t meet the income requirements or if you held a Traditional IRA at some point in your life. Once you make this change, however, you can’t go back to a Traditional IRA — permanently solidifying its status as a Roth IRA.

Converting a Traditional IRA into a Roth IRA is sometimes called a “backdoor Roth,” which is starting with one type of IRA and moving to the other. Keep in mind that you’ll owe taxes on any pre-tax IRA contributions. Once you make the change, you can’t take out any money penalty-free until at least five years after you’ve converted your account.

Opening a Roth IRA

Now that you know how Roth IRAs work, you may be ready to open one. You can go with an online brokerage account, which will help you manage your investments. Look for an account that has low fees and minimal opening balances. If you prefer more of a hands-off approach, consider a robo-advisor to help with your investing decisions.

Opening an account is only the first step. You’ll need to continue making regular contributions to ensure your investments are growing a consistent, steady pace. Whether you contribute every paycheck, month or year, adding money to your Roth IRA should always be included in your budget.

How does a Roth IRA work into your financial goals?

If you’ve decided that a Roth IRA is best for your investments, make sure you choose an investment company wisely. You can go with an online brokerage — where you choose your investments yourself — or a robo-advisor that does it on your behalf. Just remember that you have options, and should always work towards increasing your wealth for as long as you’re able to make regular contributions. You’ll be thanking yourself later — during retirement.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Dori Zinn
Dori Zinn |

Dori Zinn is a writer at MagnifyMoney. You can email Dori here

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Investing

How to Trade Stocks for Beginners

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Learning to trade stocks can be an excellent way to build long-term wealth. There’s a reason why the news reports on the stock market all the time — after all, it’s one of the most important parts of the economy. But if you’ve never traded stocks before, all this information can seem confusing and overwhelming. How do you even get started?

This beginner’s guide provides the basics on how to trade stocks. Whether you’re investing for the very first time or just need a refresher of the key concepts, we’ve covered them here.

What is a share of stock?

A share of stock represents a small ownership stake in the business. When a company such as Amazon or Nike needs money but doesn’t want to take out a loan, they can sell stock to investors.

When you buy a share of stock, you become a shareholder of a company — a part owner, in other words — and are entitled to a cut of the company’s profits. Some companies send cash directly to their stockholders, called a dividend payment, giving them their share of the year’s earnings.

Investors also make money by buying stocks, waiting for them to become more valuable, and then selling them. While you can buy shares of stock from a company directly, the most common way to buy and sell stocks from other investors on a stock market — also called a secondary market — like the S&P 500 or Nasdaq. When investors buy and sell shares on the stock market, it’s called trading stocks.

The price of a stock changes every day based on how people think the company will do. If its future prospects look good, the price will likely go up. If a company gets bad news, its stock price could go down.

How do you trade stocks?

  • Brokerage account: A brokerage account lets you buy and sell stocks and other investments. You can open one with online stock brokers, transfer money to your brokerage account and figure out which trades you’d like to make. This is the most do-it-yourself approach to trade stocks.
  • Mutual funds/ETFs: Rather than buying individual stocks, you could also buy mutual funds and exchange traded funds (ETFs). These are portfolios of stocks managed by a professional investor. When you buy in, you automatically get a share of a large, diverse portfolio so you don’t have to plan it together yourself.

Peter Creedon, a CFP and the CEO of Crystal Brook Advisors in New York, thinks this is a solid approach for beginners or investors with limited funds. “A person can get exposure to the 500 largest companies on the NYSE with just one fund,” said Creedon. He also recommended that beginning investors build exposure to many companies and possible sectors of the market, before going after an individual stock.

  • Financial advisor: If you’d like more help, you can also hire a financial advisor to suggest stocks or even manage the portfolio on your behalf. You’d need to pay them an additional fee for this advice. Some charge by the hour while others could charge a percentage of your portfolio, like 1% of your account balance each year.
  • Robo-advisor: Combining aspects of conventional financial advisors and brokerages, robo-advisors use computer algorithms to recommend stock portfolios based on your goals and preferences. They charge management fees, but they’re usually less expensive than hiring a financial advisor.

How do you invest with stocks?

Before you start putting money in the stock market, you need to figure out your investment goals. Some of the main factors to consider include:

  • Time horizon: How soon will you need your money back? If retirement is decades away, you can afford to take more risks with your stocks, perhaps buying stocks of smaller companies with more growth potential. But if you need money in a few years, you’d likely want to play it safer by purchasing stocks of more established companies, known as blue chips.
  • Risk tolerance: Imagine your stock portfolio lost a bunch of money today — 10%, 20%, even 50%. How would you feel? If losing money would really rattle you, it may be better to use safer stocks and even keep more money in cash or bonds. On the other hand, if you are OK dealing with short-term losses in exchange for higher future gains, you could be a better fit for riskier strategies like day trading.
  • Target return: How much do you hope to grow your money year after year? Investing is a trade-off between risk and return. If you want to earn more, you may need to take more risks and buy stocks with more growth potential, rather than proven blue chip companies. Just know that aiming for a higher return increases your chance of losing money.
  • Income needs: Do you need cash coming in from your stocks right away? Consider high-dividend stocks that pay out more now. In exchange, their price likely won’t gain value as quickly as growth stocks, which reinvest profits so the company hopefully earns even more in the future.
  • Amount to invest: What is your investment budget per year? Some brokerage accounts, funds and financial advisors require at least a minimum investment, for example, you may need at least $10,000. Your budget could determine your investment options.
  • Other investments: What are you doing with the rest of your savings? If it’s in safe places like cash or bonds, you could potentially afford to take more risk with your stock portfolio. On the other hand, if your money is in gold, real estate and other potentially riskier investments, you may want to be more conservative with your stocks.

How do you decide which stocks to buy?

With your goals in-mind, you can start reaching which stocks to buy. Now, without a crystal ball, it’s impossible to know ahead of-time which stocks will earn a great return. But there are strategies that can help you chances.

Bill Harris, a CFP® and financial advisor based in Massachusetts, recommends that you keep it simple. “Invest in companies that you know and that a third grader can understand.”

A different strategy would be to target sectors where you have specialized knowledge, because this can give you an edge versus the average investor. For example, if you have a science or medical background, you could focus on pharmaceutical stocks.

Research companies before you buy their stock

Putting in the proper research is also important as you figure out which companies will succeed in the long-haul. The internet and TV are full of financial news but Harris says don’t overlook your local library. “Most library systems have access to Valueline, CFRA and Morningstar. These companies do not make markets in securities, so their research is pure.”

Another useful strategy is to focus on diversification, also called asset allocation. This means you buy a mix of stocks and other assets so you don’t put all your eggs in one basket. For example, let’s say you buy both car and oil stocks. If the price of oil goes down, that might be bad for oil profits but could lead to customers buying more cars. As a result, your car stocks go up and balance off your oil stock losses.

Finally, you could use a stock market simulator to test your strategy without taking any risk. These tools let you virtually invest in stocks with play money, so you can see whether your ideas would be successful before you commit your actual savings.

What’s the difference between day trading and investing?

As you figure out your strategy, you need to decide whether you’d like to day trade or invest for the long-term. Day trading means you’re buying and selling stocks frequently throughout the day based on the most recent news. Investing in stocks takes a longer-term horizon and you’re buying stocks and holding them for months, even years.

While day trading may seem more interesting, it does have its downsides. Each time you buy or sell a stock, you need to pay trading fees. You could also owe higher income taxes on your stocks, as the IRS charges a higher tax rate on short-term gains, stocks that you sell within a year of buying. Not to mention, you’re also trying to outmaneuver all of Wall Street. As a result, making money with day trading can be stressful and challenging.

Investing may be a better strategy

The financial advisors we spoke with for this article all came out in favor of investing as a more profitable strategy. “Too many people hear a hot tip, jump in, and check the stock every five minutes. My mantra is ‘Become the owner of a company, not a trader’,” said Harris.

Harris also recommends patience with your picks and that you shouldn’t sell at the first hint of bad news. “I commit to staying invested in each position for at least one year. One year from now before I even look at the stock performance, I will make the decision if I still feel the same way about industry and that company.  At that point, I will either sell or buy more.”

Where can you get help buying stocks?

If investing in the stock market for the first time seems intimidating, well that’s because it can be. There’s a ton of information to learn, especially if you try to do everything by yourself. As a beginner, consider getting some help with your first trades. Whether it’s working with a live financial advisor, a professionally mutual fund/ETF or even a robo-advisor, all these methods would get you started on the right foot.

“For beginners, I would recommend they hire a certified financial planner to prepare a financial plan, understand their risk profile and set up an overall target allocation,” suggests Clark Randall, CFP and founder of Financial Enlightenment based in Texas.  “After the planning phase, they can either invest themselves or hire the planner to implement the recommendations.”

Learning how to trade stocks takes some work, but the returns could be well worth it. Between the information in this guide and the support of a professional advisor, you can feel confident about investing in stocks, even as a beginner.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

David Rodeck
David Rodeck |

David Rodeck is a writer at MagnifyMoney. You can email David here

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Investing

Everything You Need to Know about Spousal IRAs

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

A spousal IRA is an investment strategy used by married couples to save for retirement. There is no separate type of individual retirement account called a “spousal IRA” — rather, it’s just a traditional IRA for a married person who isn’t earning an income. IRS rules allow spouses who aren’t earning income, for whatever reason, to still use the tax advantages of saving and investing money in an IRA to accumulate a nest egg for retirement.

What is a spousal IRA?

The IRS requires individuals to report annual income in order to fund an IRA — with the exception of a spouse who isn’t earning an income, but is married to someone who is. If both partners in the marriage file taxes jointly, the IRS lets each partner have their own IRA. Married couples who file taxes separately are not eligible for the spousal IRAs approach.

According to Janice M. Cackowski, a financial advisor with providence Wealth Partners in Ohio, the IRS looks at married couples who file jointly as one entity, and their combined income as one figure, so spousal IRAs allow them to put away twice as much.

“Spousal IRAs are terrific tools when one spouse is employed and the other is not,” said Cackowski. “It allows the spouse who is earning wages to deposit them an IRA for the benefit of the non-working spouse, essentially allowing each spouse to maximize their retirement savings.”

Basic spousal IRA rules

  • The tax filing status of the couple must be “married filing jointly”
  • The married couple does not co-own a spousal IRA — it is owned by and held in the name of the non-working spouse
  • Spousal IRA can be a Traditional IRA or a Roth IRA
  • There is no longer an age limit for making contributions to a Traditional IRA, so you may keep adding money after age 70 ½, as has always been the case with a Roth IRA

Like any other IRA, married people making use of a spousal IRA strategy contribute funds to their separate accounts and invest the funds in stocks, bonds, CDs and other assets. Interest accumulates over the years, and the account grows either tax-free or tax-deferred (more on this in a bit).

For example, if you contribute $6,000 a year to your IRA starting at age 30 until you retire at age 65, the sum would grow to more than $700,000, assuming a 6% annual rate of return. This figure doesn’t account for taxes (so it’s not entirely exact), but it does show how the power of compound interest can work in your favor over time.

What are your spousal IRAs options?

Your spousal IRA can be either a Traditional IRA or a Roth IRA. The rules and contribution limits for spousal IRAs are no different than conventional versions of either account. Remember, the difference between a Roth IRA and a Traditional IRA comes down to when you can reap the tax benefits of each option, and Traditional IRAs may provide tax deduction benefits.

  • Traditional IRA: Contributions to a Traditional IRA are made before you pay income tax. As such, you end up paying income taxes on all withdrawals — principal and interest earned — when you withdraw funds in retirement.
  • Roth IRA: Contributions to a Roth IRA are made after you pay income taxes. Since you’ve already paid taxes upfront, money you withdraw in retirement is tax free.

Which should you choose? In general, if you’re in a lower tax bracket now than you expect to be when you retire, then a Roth IRA may be more beneficial, as you may save money on taxes down the road. This decision is unique in each situation.

Spousal IRA contribution and income limits

For 2020, the annual contribution limits for both Traditional IRAs and Roth IRAs is $6,000, or $7,000 if you’re 50 or older. This is the core benefit of a spousal IRA: A married couple can potentially sock away a total of $12,000 into their IRAs.

There is no income threshold for contributing to a traditional IRA, while the limit for contributing to Roth IRAs is $206,000 for married couples filing jointly. Also, In addition, for both Roth IRAs and Traditional IRAs, the married couple must have taxable income that is equal to or greater than the total amount contributed to their IRAs.

Spousal IRA tax deductions

Couples can deduct their contributions to a Traditional IRA from their taxes, depending on two factors. The income tax deduction is reduced or eliminated entirely depending on the couple’s total income, or the earning spouse’s participation in an employer-sponsored retirement plan.

If the spouse who works is covered by their employer’s retirement plan, the Traditional IRA income tax deduction is phased out when the couple’s income falls between $104,000 and $124,000. Incomes above $124,000 get no tax deduction.

However, if the spouse does not participate in an employer-sponsored retirement plan, the deduction phases out at an income level of $196,000, and is eliminated after income hits $206,000. There are also tax credits available — the Saver’s Credit — for married couples filing jointly who earn less than $65,000 a year.

Spousal IRA withdrawals

Because IRA funds are intended for use in retirement, withdrawing them before that time often comes with a penalty. For traditional IRAs, there’s a 10% penalty if you withdraw funds before age 59 ½, and you also must pay taxes on the money you withdraw. For Roth IRAs, you can withdraw the funds you contributed at any time penalty free, since you already paid taxes on them up front, but you’ll pay a 10% penalty on any earnings if you with withdraw them sooner than five years after the account was opened or before age 59 ½ (whichever is longer).

For both traditional and Roth IRAs, there are some exceptions to early withdrawal penalties for things including death, disabilities and a first-time home purchase.

Who should consider a spousal IRA?

Any family with a non-working spouse and disposal income for long-term savings that is looking to increase their retirement nest egg should consider a spousal IRA as a potential option.

According to Michelle Buonincontri, an Arizona-based certified financial planner and certified divorce financial analyst, spousal IRAs help protect the non-working spouse in the case their happily ever after doesn’t end quite so happily.

“Let’s face it, with 50% or more of first marriages ending in divorce, spousal IRAs are a great way to level the playing field by having retirement assets in the name of the spouse that does not have access to a retirement plan if a couple ever find themselves in a divorce situation,” she said.

Although retirement assets accumulated during the marriage are usually considered marital assets, Buonincontri suggested that “folks seem less emotional about letting the other spouse keep accounts titled in their own name and less tense during the marital settlement negotiation process.”

Spousal IRAs aren’t for all couples

This doesn’t mean contributing to a spousal IRA is right for every couple, however. While spousal IRAs are generally a positive investment, people need to take a hard look at their financial situation to make sure funds won’t be needed elsewhere.

Diane Pearson, a certified financial planner with Pearson Financial Planning in Pittsburgh, Penn., noted that a spousal IRA isn’t always the first move couples should make with disposable income.

She advised that couples should build their emergency fund and general savings before opting for a spousal IRA. Savers don’t want to set themselves up for additional taxes or early withdrawal tax penalties if they end up needing to pull funds out of an IRA to pay for near-term emergencies or a child’s education before age 59 1/2.

“Every situation is obviously different, but if an employer is offering the working spouse a match to a qualified retirement plan, and the individual instead decides to use their income to fund their non-working spouse’s IRA, they may be missing out on the employer’s matching contribution,” said Pearson.

How to open a spousal IRA

As we noted in the introduction, a spousal IRA is a strategy, not a distinct type of individual retirement account. Whether you choose to set up your spousal IRA as a Traditional IRA or a Roth IRA, you can do so through most banks, brokerage and wealth management firms, as well as robo-advisors.

For more help determining which might be best for your IRA needs, visit our list of the best IRA account providers, and the best robo-advisors.

How hands-on you want to be when it comes to managing your IRA will help you decide which route to go. While some providers will do all the work for you, you’ll pay for that help in the form of management fees, other brokers give you complete control over your portfolio and you save on fees.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Julie Ryan Evans
Julie Ryan Evans |

Julie Ryan Evans is a writer at MagnifyMoney. You can email Julie here