You might be thinking about a New Year’s resolution to prioritize retirement savings in 2023, but you don’t have to wait that long to get started. If you’ve got a little extra cash lying around right now, stashing it in a Roth IRA could pay off big in a few years.
High earners can’t contribute directly to one of these accounts, but this shouldn’t affect most people. If you’re eligible, here are a few reasons to consider opening a Roth IRA before we ring in 2023.
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1. You want to grow your wealth
Roth IRAs are investment accounts that enable you to purchase stocks, bonds, mutual funds, exchange-traded funds, and more. Putting your savings in these securities introduces a risk of loss, but it also opens the door to much greater earning potential than you’d get by sticking with a savings account.
The top savings accounts have annual percentage yields (APYs) of 3% or less. But it’s possible to earn a 10% annual return or even more while investing. A single $1,000 deposit could be worth nearly $17,500 after 30 years with a 10% average annual rate of return. That’s $16,500 in earnings.
These earnings reduce how much you need to set aside from each paycheck to cover your retirement costs. Plus, your early retirement contributions have more time to grow than your later contributions, and even a few months can make a big difference in your Roth IRA’s final balance. That’s why it’s best to stash some money here in 2022 if you’re able to do so.
2. You want to minimize your tax bill in retirement
Unlike most retirement accounts, Roth IRAs don’t give you an upfront tax break. Instead, you pay taxes on your contributions in exchange for tax-free withdrawals in retirement. This can significantly reduce your taxable income in retirement because the government essentially ignores Roth IRA withdrawals when calculating what you owe for the year.
There are a few catches you should be aware of, though. While you can withdraw your contributions tax- and penalty-free at any age, the same isn’t true of earnings. Earnings withdrawn before age 59 1/2 are subject to a 10% early withdrawal penalty. And if you withdraw earnings before you’ve had a Roth IRA for at least five years, you’ll pay taxes on them. If you’re under 59 1/2 and have had your Roth IRA for less than five years, you’re on the hook for taxes and penalties.
3. You’ll be able to access your earnings tax-free sooner
The requirement that you must own your Roth IRA for at least five years before you can withdraw earnings tax-free is known as the five-year rule. But the clock doesn’t start ticking on the day you open your Roth IRA.
It actually begins on Jan. 1 of that year. So, for example, if you opened a Roth IRA today and put money in it, the five-year clock begins on Jan. 1, 2022, and you’d be able to access your money without paying taxes on your earnings on Jan. 1, 2027. But if you put off opening your IRA until 2023, now you’ve pushed everything back a year. You’ll owe taxes on any earnings withdrawn before Jan. 1, 2028.
This might not make a huge difference to you if you’re decades away from retirement. But if you plan to leave the workforce soon, making a 2022 Roth IRA contribution will speed up your tax-free access to these funds.
How to open a Roth IRA
Assuming your annual income doesn’t exceed the Roth IRA income limits, you can open one of these accounts with just about any broker. Look into a few and compare their fees and investment options to decide which is best for you. You may also want to check whether there’s a way to link a bank account so you can set up recurring monthly deposits in the future.
You’ll need some cash on hand to deposit. You can decide how much you’d like to set aside, but you can’t contribute more than $6,000 for 2022, or $7,000 if you’re 50 or older.
Technically, you can make 2022 Roth IRA contributions up until the tax deadline, which is April 17, 2023. But you must specify that it’s a prior-year contribution or it’ll count toward your annual contribution limit for 2023. If you’d rather not deal with all these extra hoops, try to make your Roth IRA contributions by the end of this year.
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