Retirement should be a beautiful thing. After decades of hard work, it should be a time to embrace and do what you have been dreaming of. Whether you plan to travel the world, move to a beach in Florida, or take on a new hobby, the one common denominator is that you’ll need money to do so.
Unfortunately, as time has progressed, so has the amount of money someone will likely need to save up for retirement. The best way to make sure you’re financially comfortable in retirement is to attack it from multiple angles. Many people know how a 401(k) and Social Security work, but an underrated source of retirement income is a Roth IRA.
With a Roth IRA, you contribute after-tax money and can take tax-free withdrawals in retirement. If you’re able to, you should use a Roth IRA as early as possible. Here’s why.
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Time is arguably the greatest thing on any investor’s side — it reigns supreme. And it’s all thanks to what Albert Einstein is quoted as calling the “Eighth Wonder of the World”: Compound interest/earnings.
In investing, compound earnings occur when the money you earn from an investment begins to make earnings on itself, and it’s the number one way to build wealth in the stock market.
For example, if you make 10% returns on a $1,000 investment, you’d make $100. If you make another 10% return, you’re now earning it on the original $1,000 and the $100 you made last time, making it $110. It’s a very lucrative cycle if you let time work its magic.
If you’re investing for retirement, the earlier you start, the better, because time can do a lot of the heavy lifting. For 2022, the maximum annual contribution to a Roth IRA is $6,000 ($7,000 if you’re 50 or older).
If we assume you invest $6,000 annually, here’s how your account would stack up at age 60 based on different starting ages and 10% average annual returns:
Starting Age
Years Until 60
Personal Contributions
Account Value
25
35
$210,000
$1.62 million
35
25
$150,000
$590,082
45
15
$90,000
$190,634
55
5
$30,000
$36,630
Data source: Author calculations.
As you work backward from age 55 to 25, you’ll notice that the difference between your personal contributions and account value widens each time.
By starting at age 35 instead of 45, you can manage to have just under $400,000 more while only contributing $60,000 more over that span. By starting at age 25 instead of 35, you can have over $1.02 million more while only personally contributing $60,000 over that span. Starting early is key.
Another reason to use a Roth IRA as early as possible is that it comes with income thresholds that you may eventually find yourself over. For 2022, the income thresholds for Roth IRA eligibility are:
Filing Status
Income Level
Amount You Can Contribute
Married filing jointly
< $204,000
Up to the limit
Married filing jointly
≥ $204,000 but < $214,000
A reduced amount
Married filing jointly
≥ $214,000
None
Married filing separately
< $10,000
A reduced amount
Married filing separately
≥ $10,000
None
Single or head of household
< $129,000
Up to the limit
Single or head of household
≥ $129,000
A reduced amount
Single or head of household
≥ $144,000
None
Data source: IRS.
Even if you’re only eligible to contribute to a Roth IRA for a handful of years, it can make a huge difference considering it’ll (hopefully) continue to grow and compound even after you’re ineligible. For perspective, an investment will more than 10x in value if it averages 10% returns over 25 years.
If you’re over the income limit, you can still contribute to a Roth IRA using a backdoor Roth IRA — which involves contributing to a traditional IRA and converting it to a Roth IRA — but the tax implications of that may not make it worth it for some people.
Regardless of how much you’re able to invest, the best thing you can do is start. You don’t need a lump sum or once-in-a-generation returns for a comfortable retirement. You need consistency, patience, and a long-term focus. The short term will undoubtedly get rocky, but if you’re focused on your long-term goals, you can ignore the daily noise and focus on the big picture.
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