Maine Finance

Sep 28 2017

How does a Roth IRA grow over time? #roth #ira #compound #interest #calculator


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How does a Roth IRA grow over time?

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Roth IRAs are a GREAT tax bucket to help you save for retirement. They will grow both with additional annual deposits, Roth Converstion (from traditional IRAs) or by growth of your underlying Investments (these can be stocks, bonds, mutual funds, ETFs, real estate and sometimes even private deals). I reserve my Roth IRA personally for some of my higher growth investment ideas.

One of the things that I like about the growth of a Roth IRA is that all the growth will be tax-free when you take it out in retirement. If you compare that to other TAXABLE sources like pensions, Traditional IRA/401k withdrawals, Social Security and other investment income, it may be the only tax free source of income that you will have in retirement. This is very important especially if you believe that taxes will be higher when you retire and you would like a bucket of funds available tax free. It is also not subject to the ACA/Obamacare 3.8% Net Investment Income Tax.

One of the biggest issues with Roth IRAs is that not everyone is eligible as their income is above the annual income limits (approx $133k if single and $194k if married). To get around that, you may want to look into doing Roth Coversions – or even a Back Door Roth Contribution .

Also, many make mistakes when using Roth IRAs – here is a piece I contributed to that may help you avoid these mistakes:

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Your Roth IRA account grows over time thanks to two funding sources: contributions and earnings. While your contributions to your individual retirement account. or IRA, are the most obvious source of growth, the potential for your savings to earn interest and the power of interest compounding are equally important factors.

What Is A Roth IRA?

IRAs are popular savings vehicles among those who understand the importance of planning ahead for retirement. Rather than relying on the retirement savings accumulated through payroll deferrals made to an employer-sponsored savings plan such as a 401(k), IRAs allow even the self-employed to contribute during working years to ensure financial stability later in life.

The defining characteristic of a Roth IRA is the source of contributions. Like 401(k) plans. contributions to traditional IRAs are made with pretax dollars, meaning you must pay income tax when you withdraw the funds later. Contributions to Roth IRAs. conversely, are made with after-tax dollars, so any contributions you make are yours to withdraw tax-free at your discretion.

Roth IRA Growth

The beauty of an IRA, whether Roth or traditional, is your account can grow even in years you are not able to contribute. In addition, the amount of growth your account generates can actually increase each year through the magic of compound interest. Basically, this means that every year your contributions earn interest, your balance is increased. The following year, you earn interest on this increased balance, meaning the total amount of interest earned increases each year even if you are no longer contributing to your account. While simple interest is the interest earned on your contributions, compound interest is the interest earned on prior years interest.

Example

Assume you contribute $3,000 to your Roth IRA for 20 years, for a total contribution of $60,000. In addition to your contributions, your account earns $5,000 in interest, giving you a total balance of $65,000. To ramp up your savings, you decide to invest in a mutual fund that yields 8% interest annually.

Even if you stop contributing to your account after the 20th year, you earn 8% on the full $65,000 in the 21st year. You earn $4,800 in simple interest and $400 in compound interest, increasing your account balance to $65,000 * 1.08, or $70,200.

The second year after your last contribution, you continue to earn 8% on the sum of your contributions and previous earnings, yielding another $70,200 * 0.08, or $5,616, in total interest. Your balance is now $75,816. You gained nearly $11,000 in just two years without making any additional contributions.

In the third year, you earn $6,065, increasing your balance to $81,881. If you fast forward another five years, your account earns another $38,429 in interest, and your total balance is $120,310. Without contributing anything further to your account, your Roth IRA has nearly doubled in the past eight years through the power of compound interest .

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