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Want More Tax-Free Income? Max Out Your Roth IRA in 2021!

By Charlene Rhinehart, CPA – Jan 16, 2021 at 12:03PM

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An easy way to earn more money without increasing your tax bill.

If you're tired of paying taxes on every dollar you earn, you need to explore the benefits of a Roth IRA (individual retirement account). It's a tax-free gift on earnings that comes with built-in benefits you can enjoy now and later. You just have to make sure you have earned income, and that you fall below the income thresholds that prevent some from making Roth contributions. 

You won't get any tax break on the money you use to fund the Roth IRA, but all of your earnings grow tax-free. After you reach age 59 and a half and meet the five-year rule, every penny in your Roth IRA is yours to keep -- no need to split your earnings with the IRS. If you've ever dreamed of building a six- or seven-figure retirement fund, the Roth IRA makes this dream possible without the uncertainties of paying taxes later. But it all starts with one simple step -- maxing out your annual contributions.  

Woman holding fan of cash in front of face

Image source: Getty Images.

The power of Roth IRA contributions 

Although there are a variety of savings options available -- and you probably were given access to retirement accounts from your employer -- there's one reason why the Roth IRA reigns supreme over other accounts: You can choose your investments and take out whatever you put in at any time.

Many people automatically assume that if you touch the money in your Roth IRA before retirement, you'll be penalized and have to pay taxes. That's not the case. That rule only applies to earnings in your account that were taken out prematurely. If you contribute $3,000, you can always withdraw the $3,000 without worrying about any timing or tax restrictions. 

For 2021, you can contribute up to $6,000 to a Roth IRA if you're under 50 and have earned income. But if you're 50 and over, you get a special catch-up contribution of $1,000 that allows you to contribute a maximum of $7,000 to a Roth IRA. You're not required to contribute any specific amount every year. You just can't contribute more than the maximum allowed. 

Maximize your tax-free earnings 

The ability to withdraw contributions is an appealing feature of the Roth IRA, but maximizing your contributions comes with even greater rewards. You'll get to invest in high-quality assets that give you a better chance of earning more tax-free income in your account. That's the secret to cashing in on all the benefits that the Roth IRA has to offer. 

Imagine if you would have contributed $6,000 to your Roth IRA in 2020 and immediately purchased shares of Tesla (TSLA -0.94%). Saying that your account would have more than doubled would be an understatement. Your Roth IRA balance would have grown over 720% by the end of the year, allowing you to easily turn $6,000 into nearly $50,000. That's $44,000 in tax-free profits you can enjoy later! 

Start as early as possible 

It's tempting to brush off retirement planning until a later date, but think about it this way: The earlier you start, the more tax-free income you can accumulate. 

You should treat the Roth IRA as a limited time offer account that may not last forever. Simply put, receiving an enormous bump in your salary may disqualify you from making direct contributions to a Roth IRA, because your income exceeds the thresholds. 

That's why you should start maxing out your account right now if you qualify. Don't stop there -- open an account for your kids, too! You don't have to be a certain age to take advantage of a Roth IRA. Even a three-year-old can have a Roth IRA account, but there's a caveat: Anyone who contributes to a Roth IRA must have earned income for the year. If you made less than the contribution maximum ($6,000 for 2021), then your contribution is limited to the amount of your earned income. So if your child made $2,000 from modeling and acting endeavors, you could contribute up to $2,000 to a Roth IRA in the child's name. Opening a Roth IRA for a child at an early age is one of the simplest ways to help your child to become a millionaire before retirement

Don't leave money on the table 

The Roth IRA's tax-free earnings feature is a big deal. Taxes are the single largest expense for most people. The less money you have to pay in taxes, the more money you can keep toward your wealth-building goals. 

Start planning now. If you want to contribute the maximum amount this year, all you have to do is save $500 a month for 12 months. Then, invest in assets that will allow you to create an extra stream of tax-free income that you can enjoy during retirement! 

Charlene Rhinehart, CPA owns shares of Tesla. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.

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