A Roth IRA can be an excellent way to set money aside for retirement, but knowing how to make your money grow in a Roth IRA can be confusing.
The first thing to understand about Roth IRAs is that they don’t have their own interest rates. Roth IRAs, like traditional IRAs, are investment vehicles, which means their interest rates depend on the investments placed inside them.
So how do you decide on the best investments to put into your Roth IRA to maximize your interest rate? Unlike a savings account, money market account or certificate of deposit (CD), getting the best rate from your Roth IRA requires more than shopping around to find a competitive rate. Instead, you’ll need to be intentional about the investments you choose for your Roth IRA.
Sound confusing? It doesn’t need to be. Here’s what you need to know about getting the greatest returns from your Roth IRA.
How much would you like to invest?
A Roth IRA, like a traditional IRA, is a tax-advantaged retirement account. Both have a contribution limit of $6,000 for 2022 ($7,000 if you’re age 50 or older), and your money grows tax-free inside both account types.
The biggest differences between Roth and traditional IRAs are how each type of account is funded and taxed. Contributions to traditional IRAs are often tax-deductible (though subject to income limits), but withdrawals are taxed as ordinary income. Roth IRAs, on the other hand, are funded with money that already has been taxed, which means you won’t pay any taxes when you access the funds in your Roth IRA as long as you wait until after the age of 59 and a half to take distributions.
Because of compound interest, the best way to ensure good returns on your Roth IRA investments is to maximize your annual contribution.
For instance, let’s say you are 30 years old and open a Roth IRA. You decide to put aside the maximum contribution of $6,000 per year. Suppose you earn 8% interest, which is compounded annually. After 35 years of saving this way, you will be able to retire at age 65 with over $1.12 million, just from your Roth IRA. Not bad!
But what if you don’t start at age 30? Suppose you wait to open a Roth IRA until you are 40 years old but still contribute the annual maximum of $6,000 and earn 8% interest on your investment. If you wait until age 40 to start, you will have just under $480,000 at age 65, less than half as much as you would have had if you’d started at age 30.
Other than maximizing your annual contribution, the next best way to ensure your money keeps growing in your Roth IRA is to choose investments with minimal fees.
There are four common types of fees that affect Roth IRAs:
You can open a Roth IRA with a traditional brokerage or with a robo-advisor.
Traditional brokerage firms generally are better for investors who are more hands-on, as they allow you to choose your investments. This can be as complex as hand-picking (and buying and selling) the stocks and ETFs you want in your portfolio or as simple as deciding which three or four mutual funds will give you the diversification you want. You can expect to pay trading fees and expense ratios with a traditional brokerage. A good traditional brokerage firm will have a number of low-cost investments for you to choose from and offer retirement planning tools and information to help you make the best choice for your investments.
Robo-advisors, on the other hand, will make these sorts of decisions for you. Once you provide your investment timeline, risk tolerance and goals, the robo-advisor will build and maintain a diversified portfolio for you. Robo-advisors generally charge a service fee that is a percentage of your assets under management — usually 1% or less, although many charge 0.5% or less. A good robo-advisor will keep its fees low and offer services like automatic rebalancing and tax loss harvesting to give you the biggest bang for your buck.
Ready to get started? Explore our list of the best Roth IRA account providers.
Investing in a Roth IRA will save you the headache of paying taxes in retirement, and you’ll be able to choose your investments, hopefully maximizing your Roth IRA returns.
It’s important to remember that returns on investments are not guaranteed. Anyone who wants a solid interest rate should consider high-yield savings accounts, CDs or money market accounts. However, the guaranteed interest you get from those options tends to be much lower than the kinds of returns you can expect to receive from your Roth IRA investments over several decades.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.