When it comes to retirement savings, starting early and investing smartly can add up big time. So if you already have a Roth IRA, you can feel great about meeting that first goal. Now you can get technical with your investment strategies to maximize your return.
With a Roth IRA, your contributions are after-tax. This means they are not tax-deductible, but they provide tax advantages in other ways. Roth IRAs give investors tax-free withdrawals, provided that they meet the required criteria, such as a minimum age of 59½.
Your Roth IRA can make use of a variety of investment security types, but these securities are not all created equal. To maximize savings, you should use securities that make the most of the tax status of the Roth IRA. So it isn’t ideal to use ones that are already tax-exempt, like municipal bonds. Slow-growing securities, like low-interest-rate CDs and stocks, are also not ideally suited to a Roth IRA, but fast-growing stocks can be a good idea.
“Real estate investment trusts are also good for Roth IRAs,” according to Fool.com writer and co-writer of several Fool books Selena Maranjian. “You can also do quite well just investing in a broad-market index fund or two, or a target-date fund, in your Roth IRA. Such a simple approach can be very effective.”
Once you pick the right securities for your Roth IRA, you should be sure to max out your contributions each year. For the 2016 tax year, the contribution limit is $5,500; however, if you are more than 50 years old, the limit is $6,500. This provision allows people close to retirement age to catch up on their savings.
You may not qualify to contribute up to the limit, depending upon your adjusted gross income and your tax filing status. The IRS has a table to help you determine your limit at https://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Amount-of-Roth-IRA-Contributions-That-You-Can-Make-for-2016.
“Don’t skip years, either,” states Maranjian. “It’s easy to think that a single missed year won’t matter much, but if you made those $5,500 annual contributions for just 24 years instead of 25, you’d end up with $535,000 — about $60,000 less!”
Another strategy you may want to take advantage of is a Roth IRA conversion, which entails moving money from a traditional IRA into a Roth IRA. You will have to pay taxes on the money when you make the conversion, but there are some circumstances in which this is preferable, such as if you expect your income level and therefore tax rate to go up substantially in the next few years and want to take advantage of the lower rate.
“Since converting an IRA can result in taxes, some people may hesitate to do so during a period when they aren’t making much money and have limited discretionary funds,” says Personal Finance Writer Maryalene LaPonsie in an article for U.S. News & World Report. “However, low-income periods can be a good time to convert to a Roth IRA.”
Regardless of your current income level, you should talk to your financial institution or adviser to determine the best time to make a Roth IRA conversion and to determine the ideal securities to include in your Roth IRA.
