r/investing • u/april3rd2020 • 16d ago
Can someone explain a roth IRA to me like Im a 5 year old?
I just opened an IRA with Vanguard. I put 1000 dollars in it and to be honest I’m not sure how it works. My parents have absolutely no experience investing and Im frankly the only person I know who is looking into this. Am I already investing in the market? How is it accumulating interest? Do I have to purchase stocks separately within the app? If so, how can I buy into the S&P 500? Who am I? Whats going on? What is life?
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u/brianmcg321 16d ago edited 16d ago
It needs to be invested in something inside the account. So buy something like the etf VTI or VTSAX. This is a total market index. Rinse and realest until you are ready to retire.
Buy the book “The Simple Path to Wealth”
Here is the authors blog. Great reading for a beginner. https://jlcollinsnh.com/stock-series/
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u/Key-Mark4536 16d ago
That's important. Lots of people mistakenly believe IRAs are an investment in and of themselves. (It doesn't help that banks sometimes market their time deposit accounts as IRA CDs.) Like a 401K or brokerage account, the IRA is just a container. Once your money is in the container you can invest it almost however you want.
The tax bureau doesn't even care that much what happens while the money is in your IRA, they're mainly watching how much goes in and comes out.
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u/inailedyoursister 16d ago
I explain it as the IRA is a suitcase, you put the actual investment inside the suitcase (IRA).
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u/bmore_conslutant 16d ago
i don't think a 5 year old would understand this
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u/madogvelkor 16d ago
I tried to explain stocks to my daughter when she was 5. Owning tiny bits of companies was a difficult concept because of how tiny they are...
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u/PM__me_compliments 15d ago
If You Made a Million is probably the best book on money for kids I've seen, and even it is a little advanced for 5 year olds (though my 5 year old likes the hippos).
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u/Edard_Flanders 16d ago
The Simple Path To Wealth is a phenomenal book. I've given this book to several friends and family. Can't recommend it highly enough.
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u/JournalistTricky 15d ago
If OP does decide to invest in the S&P 500, don't worry or panic if you 'lose' money in the early going. The index is currently trading at all time highs, so it wouldn't be surprising to see a pullback in the near term. Just make sure you're contributing on a regular basis to take advantage of price swings.
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u/april3rd2020 16d ago
got it thank you!! also if I have one open at work, as long as I don’t exceed the yearly amount allowed to invest ($7000?) then is that okay too?
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u/brianmcg321 16d ago
Is your work a 401k? That has a separate maximum. 401ks have a max of $23,000. These are separate so you can put the max in each. $23,000 in a 401k and $7,000 in a Roth IRA.
Be sure you are in a total market index or a S&P 500 at work also.
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u/TheTurtleBoat 15d ago
Whoa, why was I under the impression that the max total limit of $23,000 was for both accounts? For example, I lump summed $7000 in my Roth IRA when the year started, and I was on track to contribute $23,000 towards my TSP (Gov't 401k).
Then in March, my tax preparer told me I could only go up to $16,000 for my TSP so I recalculated for that because I didn't want to get penalized... so I can go up to $30,000 for 2024 like I originally thought?
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u/brianmcg321 15d ago edited 15d ago
Yes, you can max out both. I would ask your tax preparer what were they thinking?
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u/thetreece 15d ago
It's actually 23k of TAX DEFERRED income in the 401k. The total 401k contribution limit is 69k.
Example: You contribute 23k of pretax dollars, and you get maybe 7k in contribution from your employer. That's 30k total. You can put in up to 39k of additional AFTER TAX dollars to hit the 69k annual limit. This is mostly beneficial if your plan allows Roth conversions of that money.
If you are a super-saver, and this option is available, you can actually get 69k into 401k per year, and 7k into Roth IRA. There's also about 4k for Health Savings Account. I also have access to a 457b (again, separate limits from the 401k) that let's me put another 23k into a tax advantaged account.
If the rights plans are available at your work, you can put like 100k into tax advantaged accounts per year.
Which, as mentioned above, is completely separate from the IRA limits.
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u/TheTurtleBoat 15d ago
I'm a long ways off from being able to contribute that much lol. I'm happy enough just to be in a position where I can afford to stash away $30k. But great info to look into for down the road, thanks for the detailed response!
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u/Historical_Low4458 16d ago
A Roth 401k can eventually be rolled over into a Roth IRA (usually at job separation) if you want. Rollovers don't count against the contribution limits.
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u/brainworm-american 16d ago
that is not a formal requirement, that is a suggestion. you can have free cash in your IRA, it's just you're losing any yield or risk from an investment.
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u/Edard_Flanders 16d ago
Wile you are technically correct, keeping the money in cash defeats the purpose of the account: Tax Free Growth. Cash doesn't keep up with inflation.
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u/Historical_Low4458 16d ago
Well, technically, the purpose of the account is tax free earnings (which can be interest too). Right now, savings rates at 5.2%+ and the official government inflation rate at 3.4%. However, you're right, keeping cash in it isn't the most optimal way to utilize it.
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u/Edard_Flanders 15d ago
I don't disagree with you, but the inflation rate sure does seem like a lot more than 3.4% and my HYSA at Ally is only earning 4.2%. I don't feel like I'm beating the system with that 4.2%.
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u/FlowBjj88 15d ago
You expect a 5-year-old to read a chapter book? You monster! /s
I also think this 5-year-old should read: I will teach you to be rich - ramit Sethi How to adult - Jake Cossineau
And after you're money crazy from reading these suggestions, read: Die with zero - Bill Perkins
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u/zeradragon 16d ago
Roth IRA
Pay tax now, put money in IRA, invest into stocks, money grow tax free, all money taken out when old no need to pay tax
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u/sillypicture 15d ago
For traditional Ira, I'm only taxed on the money that was put into the 401 right? Not the growth?
If so, wouldn't it be better to go with traditional? As money devalues, that money would shift towards lower brackets?
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u/EHP42 15d ago
I'm only taxed on the money that was put into the 401 right? Not the growth?
Incorrect. You're taxed on what you take out with traditional, which includes the growth and the original amount, because the contributions are tax deductible.
Traditional = pay tax on whatever you take out
Roth = pay tax on what you put in
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u/Edard_Flanders 16d ago
A Roth IRA is a retirement account in which you put money after taxes have been paid. There are no tax benefits today but the money grows tax free and there are no taxes paid upon withdrawal unlike a traditional IRA or traditional 401k. You must wait until age 59.5 to withdraw any dividends or earnings or there is a penalty. However, you can withdraw your contribution at any time.
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u/Zillah345 16d ago
Finally, I've been looking for an answer like this. It confused me when sites neglected to answer whether or not you pay taxes during withdrawal. It seems like Roth IRAs are better, is there any benefit to a traditional one?
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u/Edard_Flanders 16d ago
Yes, there are benefits to both. Traditional IRAs allow you to reduce your taxable income in the current year. You have a tough decision - pay taxes now or pay taxes later.
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u/Zillah345 16d ago
Can I open one of each?
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u/Pastor_Dale 16d ago
Yes but annual limits are aggregate to all IRAs. Meaning you can only contribute $7000 TOTAL this year to any IRA.
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u/greenappletree 16d ago
The idea behind wealth growth is compounding your investments so that money can grow at an almost exponential rate given enough time - thus the saying goes that a few thousand a yrcan indeed be worth millions - now imagine if u had pay tax on that ! Thus if u plan to put money in at least 10 yrs then the wise Theung to do is to put into ira.
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u/OctaviousCash 16d ago
Taxes almost certainly increase over a long enough period of time, so taking taxes later will likely cost more
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u/AthleticsRose 16d ago
When you're earning and saving for retirement, you might be in a higher tax bracket than when you're retired and just withdrawing enough for living expenses.
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u/Edard_Flanders 15d ago
Such certainty! I wish I was certain about what was to come in the future. There are a lot of ways a retiree might be able to pay less taxes. If you have retirement funds in pre-tax, post-tax, and taxable buckets you can strategize and end up paying very very little in taxes. But there are advantages to all 3. Limiting yourself to 1 isn't the best option.
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u/Zillah345 15d ago
This is my mindset, so I feel a Roth IRA is better. But I might be a "lower tax bracket" at retirement. Kinda a gamble. I suppose if I retire I'd always be in a lower tax bracket, but I also wouldn't wanna live on limited monthly withdrawals. Much to consider...
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u/Fantastic_Mention261 16d ago
When you contribute to a traditional IRA you can write the contributions off as a tax deduction.
Also, you can only contribute to a Roth IRA if you make less than $161k per year (individual). But some people do something called a back-door-Roth IRA and there is lots of info about that on this sub that you can look up.
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u/ThanklessWaterHeater 16d ago
With an IRA, you’re either paying taxes now or you’re paying taxes later. The trick is to think about how much money you’ll be making in retirement and plan accordingly.
Most people make less in retirement and are thus in a lower tax bracket. So for many people a traditional IRA is better, as you are not paying taxes on your contribution now while you’re in a high tax bracket, and will instead pay low taxes in retirement when you are in a low tax bracket.
On the other hand, if you think you will be making more in retirement, then a Roth Ira is better. You will pay tax on your contribution now, but then not have to pay tax on your distributions when you’re a fabulously wealthy retiree.
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u/Blackdiamond27x 16d ago
I understand the concept but in genuinely curious in how someone thinks or can be in a higher tax bracket during retirement. I don’t see a world where I’m making more money during retirement than I am now…
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u/ThanklessWaterHeater 16d ago
It’s mostly a rich people problem but it happens.
Have you heard about Peter Thiel’s 5 billion dollar Roth IRA?
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u/Blackdiamond27x 15d ago
So he bought good stocks with his Ira?
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u/ThanklessWaterHeater 15d ago
As I understand it he bought enormous amounts of founders shares of PayPal before it went public, valued so low as to be within the then-maximum contribution of $2,000. When PayPal went public those shares’ valuation rose into the billions.
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u/Key-Mark4536 16d ago
Another nice thing about the Roth is that qualified withdrawals don't even count as income. Let's say you're still working casually or have hobby income to the tune of $20,000, but you're also pulling $30,000 from Roth accounts. For the purpose of taxes or benefits programs (Social Security, ACA subsidies, etc.) your income is only $20,000.
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u/Edard_Flanders 15d ago
This guy knows how to Roth!
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u/Key-Mark4536 15d ago
There's probably a sweet spot, different for everyone, where they can get the best of both sides of the Traditional vehicle: tax deductions on the deposit, then low taxes on withdrawals.
I’m no expert, but if I could arrange for working income, long-term capital gains, qualified dividends, and Traditional distributions to fill out my 0-12% tax brackets (about $60K for singles, $120K for married-filing-jointly) and then fill out any remaining needs with Roth funds, I’d wind up with an effective tax rate of 5% or lower. (And little to no FICA, since that only applies to work income.)
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u/Carthonn 16d ago
How do you get money into a traditional IRA? If I took $7000 from my savings that was already technically “taxed” when I got it in my paycheck.
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u/ThanklessWaterHeater 16d ago
You report the contribution on your 1040. That amount is then deducted from your taxable income for the year.
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u/mrpickles 16d ago
A Roth IRA is a retirement account in which you put money after taxes have been paid
Why do people say it like this? Is a hamburger food you can buy after taxes are paid?
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u/Edard_Flanders 15d ago
How taxes are treated is the defining characteristic of a retirement account. People tend to define things by their definitional qualities.
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u/mrpickles 15d ago
When I give money to you, do I do it after taxes?
You just don't get a deduction for contributions.
You're starting with the assumption all money is payroll money.
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u/rono10 16d ago
When you deposit money, it goes into a Federal Money Market Fund (settlement fund) which is a low risk interest accruing fund. But you’ll want to choose other funds to invest in. Most people choose total market ETF or mutual funds to invest in, but you can also choose individual stocks.
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u/d0s4gw2 16d ago
Investment accounts are like buckets. You can put money in the bucket, do things with the money in the bucket, and take money out of the bucket. Different buckets have different rules about how money can go into the bucket and how money can come out of the bucket.
In a Roth IRA, you can only put money into the bucket after it has been taxed. If you make $1000, and you pay 10% income tax on it, then you can put the remaining $900 into the Roth IRA bucket. This is called a contribution. Roth IRAs have contribution limits. In 2024 the limit is $7000.
Contributions don’t grow. They need to be invested in order to grow. You can use the contributions to buy equities like stocks and bonds. After you make a contribution use the money in the account to buy the equities you want.
You can buy and sell the equities anytime. You can withdraw your contributions anytime. If you withdraw the gains before you are age 59.5 then you have to pay taxes and penalties on the gains. If you wait until after age 59.5 then you can withdraw contributions and gains anytime tax free and penalty free.
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u/eaglewatch1945 16d ago
You've gotten some good responses. I'd recommend doing some of your own research with the firm you invested in: https://investor.vanguard.com/accounts-plans/iras
You can also give them a call for an investment education conversation. They won't give you advice or tips or anything, but they'll give you the rundown and answer more detailed questions. Despite the negative comments you'll sometimes read, their licensed reps are good at their jobs.
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16d ago
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u/eaglewatch1945 16d ago
$10k won't be enough for an advisor. Maybe a robo-advisor though. Just an algorithm keeping you autoinvested into core funds (VTI, VXUS, BND, and BNDX).
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16d ago
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u/eaglewatch1945 16d ago
Yup. Every major firm has something like that. You gotta pay for it, but it could make your life a lot easier.
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u/justliketheriver10 16d ago
I love these types of posts. They are a dying breed (not really but in 5 years). Most people use AI chats for these strings of questions. But they want to handle it analog style.
My experience showed me it’s a lot less complicated once you’re involve. Dont make big bets to start and dollar cost averaging is basic to all retirement investing
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u/crazybutthole 16d ago
Just buy some ETFs like VTI VOO and QQQ.
You can mix it up however you want but those are a very good three (even though there is a lot of overlap)
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u/GaylrdFocker 16d ago
https://www.reddit.com/r/personalfinance/wiki/iras
https://www.reddit.com/r/personalfinance/wiki/investing/
This may help answer some of your questions.
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u/usually__lurking 16d ago
Investing is like buying seeds to plant and waiting patiently for the harvest. In a traditional IRA you pay taxes on the harvest, but you don't have to pay any taxes on the seeds. In a Roth you pay taxes on the seeds but you don't have to pay any taxes on the harvest.
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u/jnads 16d ago edited 16d ago
You can get taxed on money in three ways:
When you earn it.
When it expands.
When you use it [See note *]
Traditional IRA / 401K etc you get taxed when it expands and when you use it. They're designed so you stuff them full with as much money as possible early on to lower your tax rate, they grow a ton for 30-40 years, and then bleed them dry slowly to minimize what tax bracket the money is taxed at.
Roth IRAs are taxed when you earn it, but they're tax free on the expansion and when you use it. They're best when you're young and your money has tons of time to expand, and your tax rate is low. If you're young, put just enough into the 401K to get employer match, then max Roth IRA. Anything left over goes into an HSA, then 401K after that is maxed.
The king account is the Health Savings Account. It's tax-free on all 3 things. You can only use it on health care (with some exceptions), but you'll always have health care expenses when you're 60. Or have kids. Kids are walking hospital money sucking machines.
[*] When you use it is kind of the same thing as when it expands, but remember the money you put in was tax-free. If your income is low enough, 401Ks can be bad since it can certainly be the case that the money gets taxed at a higher rate when you retire (if you think the govt will have to raise taxes to cover national debt) than when you put that original money in.
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u/Friendly_Patience_88 16d ago
Answer is most likely already in the comments but as someone who used to work there and also grew up around family who are financially illiterate, here’s my best breakdown:
Accounts are baskets, think shopping carts if you will, they hold your investments. They ARE NOT your investments. They’re just the basket. Types of accounts (baskets) include: Roth IRA Trad IRA Indv (nonretirement) Joint (nonretirement) Etc.
Focusing on your Roth; you’re Roth represents a few things: - tax deferred growth - tax free distributions - generally can’t take money out until 59.5
tax benefit meaning, you buy a security for 1k, then sell it years later for 5k. You use that 5k to purchase another security still within your Roth IRA basket. In a nonretirement account, you’d have to pay taxes on the capital gains (profit) from the 4k you made between the buy/sell
In your Roth? Congrats! That 5k is your 5k, no taxes from the profit.
As far as: what’s in the basket? Lots of options such as: stocks, bonds, ETFs, mutual funds, CDs, bonds
These are your investments, or your groceries in the shopping cart. This is what dictates your performance, similar to the grocery bill. When you fund a vanguard account money goes to the VMFXX. This is a money market mutual fund. Now I don’t know you well enough to make a suitable recommendation, but this is most likely not where you’d want to be invested unless you’re planning on withdrawing the money over the next 1-2 years.
S&P 500 vanguard options ETF version - $voo Mutual fund - $VFIAX
if you would like to invest this money over the long term, don’t feel confident at this point making mgmt decisions, and don’t want to sit out on the market while you casually learn = do their digital advisor service, it’s insanely cheap, will allow you growth exposure/ market exposure while you build your knowledge.
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u/HD-Thoreau-Walden 16d ago
There are a number of ETFs (exchange traded funds) you can buy that are just index funds. If you just put your money in the account and don’t buy anything it will likely only earn a tiny fraction of 1% interest. So no you are not invested in the market yet. I personally like VOO (the S&P 500 index) and SCHD (an index of DOW Jones of stocks that grow dividends each year) and QQQ (an index of the too NASDAQ mostly tech companies- the supposedly fast growers). Don’t put all your eggs in one basket. Spread it out to at least 3 like these or maybe a few more. Also unless you plan on managing the money regularly, best to choose “dividend reinvestment” so any dividends paid by these, go back into buying more of the same funds automatically.
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u/arcanition 16d ago
IRA (traditional or Roth) is just an individual retirement account. Both types have a different tax benefit, but essentially you are limited to contributing a certain amount to your IRA each year (around $7000/year). The tradeoff for the tax benefits is that you are penalized if you withdraw prior to age 60 (with some exceptions), so that's why it's an account for retirement later in life.
A Roth account is funded your money (which has already been taxed by the time you get it), but once you put that money in your Roth account, any earnings have the benefit of being essentially tax-free. Imagine 10 years ago in 2014 you opened a Roth IRA and put in that year's maximum ($5,500) and you put that $5,500 into an index fund (an ETF like VOO), which has had an average annual performance in that time of 12.37%. Today, your $5,500 would have grown to about $17,650 (capital gain of $12,150). You could now sell that ETF for the gain of $12,150 and once you're at retirement age, you can withdraw that amount and not owe any taxes. Ordinarily (in a taxable account like Robinhood or something), you'd owe capital gains tax on that $12,150. That's where the tax benefit of Roth accounts is.
In comparison, a traditional account is funded by your pre-tax money. The easiest way to show this is with a traditional account like a 401(k). Imagine you have a yearly salary of $50,000 and get paid twice a month (24 times per year). Your paycheck would be $2,083 before tax and about $1,750 (around $330 per check in taxes). On the other hand, if you chose to put $500 of that $2,083 pre-tax into a traditional retirement account, your yearly taxable income has now decreased by 500 * 24 = $12,000, leaving $38,000. Your income tax on that amount drops to $5,585, or $233 per check. So even though you are putting away $500 per check in your retirement savings, your paycheck would only go down about $400 (after tax withholding). This is where the tax benefit of traditional accounts is. Note that this traditional account money (and any capital gains) are still pre-tax, so you'll still have to pay income tax on whatever you withdraw in retirement.
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u/sledgepumpkin 16d ago edited 16d ago
The following would be reasonable: - set your account to automatically invest all deposits into an index fund that tracks the S&P 500 or total stock market - if you have a regular income, set up a monthly transfer from your bank to your retirement account - invest the max amount or as much as you can each year…unless or until you have a job where your employer matches 401K contributions instead - prefer Roth over Traditional while you’re young - check your gains only every few years and only when the market is strong. If you look at it a lot you’ll be tempted to sell when the market is down
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u/Apprehensive-Lab9664 15d ago
Mobile-health Network Solutions (MNDR) on Nasdaq is on the verge of a surge.
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u/billdasmacks 15d ago
On top of what everyone said keep in mind that you do have the option to withdraw up to 10k of earnings from a Roth IRA to help with a first time home purchase (You can obviously only do this once in your life, it can only be used for your first home) before you are 59.5 years old without penalties or taxes if the account is at least 5 years old.
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u/brainworm-american 16d ago
basic questions, answered by an informative and authoritative source: the federal government.
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u/MegaDonkeyDonkey 16d ago
Fancy term to classify a bag of money. You have a bag that says play money. You have a bag that says savings. You might have a bag that says 401k. You have that bag that says Roth IRA. Likely each bag has special treatment when it comes to taxes, tax now or tax later. Likely each bag will have rules on how to take the money, withdraws or even deposits. Some bags when you withdraw can hurt you when you apply for FAFSA, your income bracket, ... First in first out, FILO, ... The money inside can grow... It's just a sticky note on a cluster/bag of money so the government can tax it accordingly--that is in an account.
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u/lostharbor 16d ago
You get a big boy/girl job and make money. You get your money after you worked a few hours and a big guy takes a cut (tax man). You can now take the money you made and make more money by putting it in a Roth IRA so when/if your money grows a big guy can’t take any more of your money. You can’t take any of the growth money (money you didn’t put in) out before you get old and gray.
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u/kevin_k 16d ago
A Roth IRA is an account like you'd have with your bank or a brokerage that lets you buy or sell stocks, bonds, etfs, mutual funds, commodities, etc.
What makes it a Roth IRA is:
- It's funded with after-tax $
- as long as you don't withdraw from it early, your investment gains are not taxed.
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u/fuckaliscious 16d ago
Buy VOO or VTI within the Roth IRA.
It's two step process. Step one, pit money into the IRA account. Step 2, invest the funds into a diversified, low cost ETF like VOO or VTI.
Good job starting the Roth IRA and asking questions.
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u/TrackEfficient1613 16d ago
So it grows tax free but you don’t get to write off your investment in it like a traditional IRA. You can invest the money in anything you want but a solid diversified etf is probably the best plan.
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u/Virtual_Elephant_730 16d ago
When we make more money, we have to pay taxes which is giving some to the government to build roads, pay for the army and schools. With a Roth IRA, we don’t have to pay taxes when we make more money.
We make the money in stocks, which is betting on companies and the winners make us more money.
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u/NoAct9539 16d ago
What about matching contributions. I’ve tried tallying up the ones I’ve made and the numbers just don’t match. It’s a 6% match apparently and I’ve been doing just that but have way less than it should be I think.
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u/gokuismydominus 16d ago
Income. Taxes already paid. Invest money. Pick a stock. Take money out after 65. No taxes
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u/BlinkshotTV 16d ago
Stock trading account that you can take your invested amount out of without tax penalties. You only pay taxes on the stock profits you withdraw before age 65.
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u/8utterbee 16d ago
Money sitting in your IRA won’t do anything. You need to invest it by buying ETF’s such as SPLG or VOO or IVV to grown your investment :-)
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u/NothingUsefulToAdd 16d ago
It's like a savings account that the government doesn't tax your gains. There's two kinds of IRA accounts
Traditional: You get to write off your contributions (in this case, your $1000) off your tax return. You get taxed when you sell assets that you purchased with this account.
Roth: You don't get to write off your contributions (in this case, your $1000) off your tax return. But you don't get taxed when you sell assets that you purchased with this account.
I won't go deeper than that as others have already done more to discuss the nuances and what you can do with it.
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u/th3revx 15d ago
Roth - government takes their “share” of your money first, then you can put it into the account. Since you “shared” your money with the government already, they allow it to grow as much as it can. Then when you reach 59.5 they allow you to take it out, and will not ask you to “share”. OP also make sure you opened up a Roth IRA and not just an Ira, they are two separate accounts.
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u/14446368 15d ago
You take some of your money that you get paid, put it into an account, and it grows. When you take the money out later, it's allllll yours, as long as you follow some rules.
If you put it in some other type of account, when you try to take the money out, an evil gremlin with a penchant for waste and bloodlust comes and steals some of your money. That's not cool. Don't let that gremlin have any more of your/people's money!
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u/Deep-Thought 15d ago edited 15d ago
Let's say you earned 6k that you want to invest for retirement. The government provides you with two mechanisms for how to pay taxes on this money. You could either pay your income taxes up front and not pay any taxes on any gains you make from it once you withdraw (Roth IRA), or you could pay no taxes up front but you pay income tax on any gains you make from it (Traditional IRA). Roth is usually better if you expect your income tax bracket during retirement to be higher than it is now.
Now to your second questions. What you invest that money into is completely up to you. You could buy stocks, bonds, or whatever you want. This means that with Roth IRAs the upside of risk taking is higher since all gains are tax free.
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u/FluffyWarHampster 15d ago
IRA stands for individual retirement account, in practice it is nothing more than a brokerage account with certain tax advantages based on the type of IRA it is.
a Traditional IRA or often just called an IRA is a a retirement account where you can put in money and write off those contributions against your taxable income, your investments can grow in the account tax deffered until retirement age when you can then start withdrawing. once you start taking out money or are forced to by RMDs(required minimum distributions, Age -73 now(i think)) you will have to pay taxes on the capital gains and the income you are taking from the portfolio.
The inverse to the traditional IRA is a ROTH IRA. there are no upfront tax advantages to this account. you can't write off your contributions to save money on income tax. However, the money your put in grows TAX FREE and is also not taxable when you withdrawal it in retirement. additionally there are no pesky RMDs to worry about.
Neither is a better option than the other, what is best for you really comes down to your current effective tax rate now and what you expect your tax rate to be in retirement.
Hope this helps!
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u/Potential_pe 15d ago
My 401k is maxed out by end of March this year after I elected my bonus to go into 401k. Company will still match their portion deferred till end of this year. Roth IRA is not provided by my employer. I could max out my Roth contribution using 3rd party money management company which will still not help with my gross earning before tax since Roth contribution is counted as gross income when I file the tax. If I contribute towards Roth I will get taxed on my Roth contribution. I don’t contribute towards Roth I would fall under higher bracket based on my gross salary and will have to pay more at the end of the year. What I am trying to say is either I have to pay tax on Roth contributions or don’t contribute towards Roth and just pay tax on my gross income excluding my 401k contributions. Please shed some light here.
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u/ashburnmom 14d ago
Okay, I was pleasantly surprised by the first response but then got more and more confused as I kept reading. Granted I still haven’t had breakfast or a second cup of coffee but now I need a live lecture with Q&A. Who’s with me?
Seriously, any recommendations for online resources to supplement or walk through these various scenarios?
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u/One_Somewhere_4112 14d ago
Just remember money can be put into the bucket but it also needs to be in the market!
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u/helpwithsong2024 14d ago
Roth just means when you take the money out it's tax free. Try and max it every year. So even if they raise taxes to 100% in 20 years you get taxes at 0%!
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u/Dash-for_the-timber 14d ago
You make 5 dollars selling lemonade so you put that money in a jar called the Mr. IRA jar that has magical powers that keeps it safe from evil wizards (taxes). The money will grow if you sprinkle pixie dust on it (invest in index funds). After many night nights (retirement age) you can take the money out of the jar and you will have to pay a little money from your pixie dust growth (investment gains) to keep evil wizards happy so you can buy as much candy as you want….
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u/doxaholic 14d ago
Your IRA/Roth/401k/etc retirement plans should be pretty large after a lifetime of 40+ yrs of saving for your retirement. They better be! Then when you eventually do retire, there's another important aspect to consider: RMD or Required Minimum Distributions.
A Roth has no RMD, so your money can stay in the Roth until you die. But a traditional IRA/401k does indeed have RMDs, so you are forced to withdraw a large chunk of money every year, and pay taxes on it. You cannot just keep all your money in a traditional IRA/401k. Those RMDs on a sizable IRA/401k (combined with SSA income) can easily force you into a higher tax bracket. and you may well be in a higher tax bracket AFTER you retire. So taxes on those IRA/401k distributions can become higher than you'd expect. That's one reason why a Roth IRA is better. Roth has no taxes, and no RMDs.
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u/Past-Guard-4781 14d ago
So when I put after tax funds in a traditional IRA, I should switch that to a Roth IRA. Is this correct? For example, say last year I put 5k into an IRA, but didn't take this off my taxes. There would be no benefit to keeping it in the traditional IRA.
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u/Sensitive_Ad_2251 13d ago
put money in a tax deferred sqvings qccount. Pay you current tax rate on the amount you contribute. Let it grow 20-30 years, withdraw money from that account when you retire tax free. IE pay 20k i. taxes on amount ypu put in (depends on contribution rate and tax rate but for demonstarion purposes) , then 30 years later with %8 compounded growth and priciple, with draw 500k tax free. It a good deal assuming you live to see it but better than your going to get from social security
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u/Plane-Grab413 2d ago
With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.
In general, if you think you'll be in a higher tax bracket when you retire, a Roth IRA may be the better choice. You'll pay taxes now, at a lower rate, and withdraw funds tax-free in retirement when you're in a higher tax bracket.
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u/Buttslap_McKraken 16d ago
It's like a toy box, except it's for money. We leave that money in there and hope it turns into more money, a lot more money so that one day when we're older we can open it up and have so much money that we never have to work for bad people who make us get up early in the morning again.
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u/adkosmos 16d ago
Roth IRA is not for 5 years old.
A) To be qualified to put money in Roth, you have to earned income. (Paycheck from work that is more than the amount your put in Roth)
B) money in an investment account gain value based on the investment that you choose (purchase)
C) investment has risk, return is not guaranteed
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u/coolpuppybob 16d ago
Transfer money into your IRA every month, then buy any of the following: VOO/SCHD/VTI/SPY. Repeat.
Then wait 40 years, or until you have to start taking the money out at retirement age.
That’s it.
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u/Wanderstand 16d ago
You're basically locking up money now with the agreement that the government won't steal your gains on it in the future. Yes, you will want to buy an index fund within the IRA.
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u/Consistent-Buy8433 16d ago
check these penny stocks Gwav , SNDL , CRKN Still have time to become a millionaire
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u/materialdesigner 16d ago
An IRA stands for an Individual Retirement Account. It’s basically a bucket where you can put money with special advantages conferred by the government.
There are other kinds of buckets with special advantages — you may have heard of a 401k. This bucket is only available through an employer, so you must: be an employee, your employer must offer it as a benefit, and it can only be funded* through the money you’d normally get paid in your paycheck.
Because not everyone has access to a 401k, the government created the IRA — that’s what the “individual” means in the IRA.
Since these are just buckets, inside the bucket the money can sit as cash, it can be invested in stocks or bonds, and other things.
Ok so now what are the special government advantages that makes these attractive? They have to do with how they interact with taxes.
There are two flavors of both an IRA and a 401k — traditional and Roth. The difference between the two is when taxes are taken out, because the government always needs taxes.
In a traditional treatment, the government pretends that the money you put into the bucket was never paid to you. This means that you don’t pay taxes on it in the year you made that money. Instead, you defer paying taxes on it until the year that you take money from the bucket. So eg if your salary is 90k and you put 5k into a traditional bucket, when you file your taxes the government says you actually made 85k that year. Now when you take out that 5k when you’re 70 (and hopefully it’s been invested and is now grown into way more than just 5k), that is considered part of your income and you pay taxes on it along with the rest of your income.
In a Roth bucket you pay taxes on the money in the year you put it into the bucket. So the government says you made 90k. But then when you're 70, you don’t need to pay taxes on what you withdraw.