Every person's retirement will indeed look different. You have people who wish to travel the world, some who want to pick up a new hobby, some who want to spend their days at the beach, and countless other scenarios people envision for their retirement years.
Regardless of what retirement looks like for you, one thing is generally universal: The more money you have, the easier it will be to bring your ideal retirement to life. And while making more money may not be an option for some people, almost anyone can save more money.
One of the best ways to save money for retirement is by using retirement accounts that offer tax breaks. One such account, a Roth IRA, can be a great tool to easily save retirees thousands of dollars.
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How Roth IRAs work
Roth IRAs differ from retirement accounts like 401(k)s and traditional IRAs because you receive your tax break on the back end. Your tax breaks from a 401(k) or traditional IRA are on the front end, with the chance to deduct your contributions and reduce your taxable income for that specific year. However, you'll pay taxes on any withdrawals from those accounts in retirement.
With a Roth IRA, you contribute after-tax money and can receive tax-free withdrawals in retirement. The only requirements are that you be at least 59 1/2 years old and have made your first contribution to the account at least five years prior to taking the withdrawal.
The tax breaks from any retirement accounts are a good thing. However, the ability to have your investments compound over time can have a tremendous impact on your retirement finances.
The power of tax-free withdrawals in retirement
To see just how lucrative tax-free withdrawals in retirement can be, let's see how different monthly investments would stack up, averaging 10% annual returns (the long-term average of the S&P 500) over 25 years.
| Monthly Investments | Total Value | Capital Gains |
|---|---|---|
| $200 | $236,000 | $176,000 |
| $300 | $354,000 | $264,000 |
| $400 | $472,000 | $352,000 |
| $500 | $590,000 | $440,000 |
| $580 | $684,500 | $510,500 |
Table by author. Figures rounded to the nearest hundred.
I capped the example at $580 monthly because the maximum amount you can contribute to an IRA -- both Roth and traditional combined -- in 2024 is $7,000 ($8,000 if you're 50 or older). Even so, modest $200 monthly investments could lead to six-figure capital gains.
If those same investments were made in a regular brokerage account, anyone making over $47,025 ($94,050 if married and filing jointly) would owe 15% or 20% in capital gains tax. Here's roughly how much they could expect to pay in taxes:
| Capital Gains | Taxes Owed at 15% | Taxes Owed at 20% |
|---|---|---|
| $176,000 | $26,400 | $35,200 |
| $264,000 | $39,600 | $52,800 |
| $352,000 | $52,800 | $70,400 |
| $440,000 | $66,000 | $88,000 |
| $510,500 | $76,575 | $102,100 |
Table by author. Figures rounded to the nearest hundred.
By using a Roth IRA, a person could save thousands in taxes in retirement.
A Roth IRA may not be the best choice for everyone
Despite the many benefits of a Roth IRA, such as flexibility and the tax break, a con is its income limit. For 2024, the maximum amount of adjusted gross income you can have and still be eligible to contribute to a Roth IRA is $161,000 if you're single and $240,000 if you're married and filing jointly.
The income limit is high enough not to apply to most people, but it's worth keeping in mind for anyone getting close to that line. Your investments will continue to grow in a Roth IRA even after you're ineligible to make new contributions, so it's good to take advantage of it while you can.
Even if you're eligible to contribute to a Roth IRA, it might not always be the best IRA option for you. People in their peak earning years may want to consider a traditional IRA to get the tax break now while they're in a higher tax bracket, and then pay taxes on withdrawals in retirement when their tax burden may be lower.
Regardless of your option, utilizing retirement accounts is a great way to kill two birds with one stone. You lower your tax burden while putting yourself in a position to be financially comfortable in retirement. You'll surely appreciate the benefits when you see just how effective they can be.
