Out of all my investments, the Roth IRA is my favorite account. Why? It is because I won’t have to pay any tax on the gains in this account. I don’t plan to withdraw until I’m 60 and not having to pay any tax or penalty at that point is a plus. (See the end of the post for the qualification flow chart.) Additionally, if we really need some money due to an emergency, I can withdraw the contribution with no penalty. The Roth IRA will also give us more tax strategy options when we finally withdraw from our retirement funds. We can avoid the higher tax bracket by mixing the withdrawals from both the traditional and Roth IRA.
Previously, I assumed that everyone knew how to contribute to a Roth IRA, but recently I found out that some of our readers would like more information. So today I’ll go over how to start contributing to a Roth IRA.
Save up some money
Before investing in an IRA, you should have enough money to cover an emergency. Most experts recommend enough funds to cover 3-6 months of expenses, but even $1,000 would be helpful. Once you have an emergency fund, then you can save up some cash to put toward the Roth IRA. You probably would want to save up at least $500 to invest in the Roth IRA before opening a new account.
*Note: you can only invest “earned” income in the Roth IRA.
Decide where to open a Roth IRA account
Most financial institutions offer some kind of Roth IRA. Big banks like BofA offer CD and Money Market IRA options. These are very safe, but the rates are pathetically low. Personally, I don’t see the point of investing in these accounts. The big advantage of the Roth IRA is you won’t have to pay tax on the gain. If you only make 1% a year from your investment, the tax saving will be negligible. I think it’s better to take a bit more risk and invest in the stock market with a brokerage especially if you are young and have over 20 years before retirement.
You can open an account at any brokerage, but I recommend a low fee online brokerage. I use Firstrade because their fees are very low. I used them for years and their customer service is quite good. I have been able to get help on the phone whenever I need it. New investors should pay close attention to the mutual fund transaction fee when opening a new brokerage account. The mutual fund transaction fee is usually much higher than the stock transaction fee. For example, Ameritrade charges $49.99 to trade no-load mutual funds. Firstrade now charges $0. You can’t beat that.
Fees at Firstrade
- Stocks and ETFs: $0
- Mutual funds: $0
Opening an account
You will need to gather the following information to open a new account.
- Social Security Number or Taxpayer ID Number
- Employer’s Name and Address
- Date of Birth
- Bank account and routing number (if funding electronically via ACH)
- For IRAs: Name, address, social security number, date of birth of beneficiary(ies)
Now you are ready to open a Roth IRA. Here is the first page of the application.
Select the Roth IRA. I would skip the other features for now. You can always add them later if you’d like. The easiest way to fund your account is through electronic funds transfer. After this, just fill out the forms. It should take around 10-15 minutes to do so.
Funding your account
You can set up auto deduction while filling out the forms or you can do it later as well. I like to transfer the maximum contribution amount ($6,000 for 2019) early in the year and invest it when there is a pullback. For many young people, this is a lot of money to invest at once. It might be easier to set up an automatic deduction and invest $200 per month to start.
What to invest in
For beginners, I recommend investing in low fee mutual funds or ETFs. If you add to your investment consistently over a long period of time, you should be able to build your wealth. It’s really great that Firstrade no longer charges a fee. New investors can pick a good passively managed mutual fund and invest $500 to start with. Then add $200 every month without worrying about fees. In the old days, you can’t do that because the transaction fee was so high. Well, it’s still high at most other brokerages. Hopefully, Firstrade will other brokerages to lower their transaction fees too.
For new investors, I recommend putting everything in VTSAX. This is Vanguard’s Total Stock Market Index Fund. The market will go up and down, but don’t worry about it. Just keep investing and you’ll come out ahead in 30 years. Once you learn more about investing in the stock market, you can trade these in for no fee and buy something else.
How to Trade Mutual Funds at Firstrade
You can log on to Firstrade and click on the Trading tab up top. Then click on Mutual Funds, below the Trading tab. Once you are there you can trade mutual funds. In this example below, I asked to buy $500 of VTSAX. The trade will execute at the end of the trading day. Click on preview and then submit the order. See it’s easy to start investing in your Roth IRA.
Why I love the Roth IRA
Let’s summarize why I love the Roth IRA.
- No tax on the capital gain
- I can withdraw the contribution at any time with no penalty
- No RMD (Required Minimum Distributions) You aren’t forced to take your money out if you don’t want to.
- Pass on to your beneficiary with no tax. Your heirs continue to benefit from the tax-free status.
- More tax flexibility
If you don’t have a Roth IRA account yet, you should make it a priority to open one. The Roth IRA is a great deal for young folks because over 30-40 years, the earnings can easily grow larger than the original contribution. Why pay tax on these earnings if you don’t have to? Let me know if I can answer any questions. I hope this is helpful for some readers. Good luck!
Another question new investor has is whether to invest in their 401k or Roth IRA first. I advise them to focus on their 401k first. Max that out and then invest in the Roth IRA second. You can read more here – Should I invest in 401k or Roth IRA?
- What if you always maxed out your 401k? You’ll be a millionaire if you max out your 401k every year.
- Build a Roth IRA conversion ladder to minimize taxes in early retirement. This is how to access your retirement account before 65.
*Sign up for a free account at Personal Capital to help manage your net worth and investment accounts. I log in almost every day to check on my investment. It’s a great site for DIY investors.
Distribution flow chart
Here is the distribution flow chart from the IRS if you want to learn more about withdrawal.
Passive income is the key to early retirement. This year, Joe is increasing his investment in real estate with CrowdStreet. He can invest in projects across the U.S. and diversify his real estate portfolio. There are many interesting projects available so sign up and check them out.
Joe also highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.