The Roth IRA (individual retirement account) is loaded with beautiful benefits that can make it a bit easier to fund a tax-free lifestyle later. Unfortunately, the road to success isn't always easy if you don't truly understand how a Roth IRA works and how you can maximize your perks.
If you're just getting started with a Roth IRA or have no idea how to take full advantage of it, here are some common mistakes to avoid this year if you want to tap into its wealth-building potential.
1. Not contributing as much as possible
The Roth IRA is a true test of discipline. There are no minimum contribution requirements every year so it may be tempting to only contribute your spare change or skip contributions altogether. This can limit the growth of your account, making it harder to achieve the desired million-dollar Roth IRA milestone.
If you want to tap into the full potential of your Roth IRA, start contributing as much as you can. For 2021, individuals under 50 can contribute a maximum of $6,000 as long as earned income for the year is at least $6,000. Savers 50 and over receive an annual $1,000 catch-up incentive, which raises the maximum contribution to $7,000.
One of the main reasons you want to take your Roth IRA seriously is because this opportunity may not last forever. If you expect to make more money in the future, it's a good idea to consider a Roth IRA now. As soon as your income skyrockets past the income range, you will no longer be able to make direct contributions to a Roth IRA.
Below is a glimpse of the Roth IRA income phase-out ranges so you can get a better idea of the contribution warning zone. When your modified adjusted gross income (MAGI) goes beyond the range, you'll have to find alternative ways to take advantage of individual retirement account perks.
Roth IRA Income Phase-Out Ranges
2021 MAGI Range
Single or head of household
$125,000 to $140,000
Married filing jointly
$198,000 to $208,000
Married filing separately
$0 to $10,000
2. Not investing your contributions
You can be a master at maxing out your Roth IRA every year. Unfortunately, if you don't invest your contributions in assets that can supercharge your portfolio's growth, you're just holding on to a glorified savings account.
Here's the purpose of the Roth IRA: contribute money you've already paid taxes on, take advantage of tax-free growth from your investments, and enjoy all the earnings in your account tax-free when you hit retirement age.
Let's say you make an annual contribution of $6,000 for 40 years. Because time and growth work wonders in your portfolio, with just a 7% annualized rate of return, you'll transform $240,000 into more than $1 million. If you don't invest your contributions, you'll miss out on exponential growth that can set you up for a comfortable retirement.
3. Not starting as early as possible
It's never too early to get your hands on a Roth IRA. Even your two-year-old son who earns money as an actor can have money contributed to a Roth IRA on his behalf.
To contribute to a Roth IRA, a person must have earned income for the year and their income cannot exceed the limits. However, you cannot contribute more to a Roth IRA than you earn in any given year. If your child only earns $2,500 for the year, the maximum amount that can be contributed to a Roth IRA on their behalf is $2,500.
Although it may be easier to brush off retirement planning, the best way to secure your future is to start right now. With time on your side, you won't be under pressure to create the perfect retirement portfolio in just a few years. You'll be able to test the waters, see what works best for you, and create a portfolio that aligns with your goals over time.
Don't let these mistakes cost you millions
Although the above mistakes won't lead to penalties from the IRS, they can limit how much money you are able to accumulate in your Roth IRA.
This special retirement account flaunts an incredible feature that's hard to find anywhere else: tax-free income. The more money you contribute and invest over time, the more tax-free income you can earn later. If you build your Roth IRA to $1 million, you'll be able to withdraw every penny tax-free after you've reached age 59 1/2 and have adhered to the five-year rule.
The best move you can make now is to start thinking about what retirement looks like for you. Then determine how you can leverage a Roth IRA to make your dreams come true. After you do this exercise, you'll turn the most common mistakes into opportunities to produce millions in your retirement account.