Easily Save Thousands When You Take Advantage of This Retirement Account

Everyone knows they should save for retirement; that part is pretty straightforward. More importantly, though, if you're going to be saving and investing for retirement, you might as well get some tax benefits along the way. A 401(k) is by far the most popular type of retirement account, but it's not the only one. IRAs can be great options to help supplement your retirement savings.

There are two types of IRAs: traditional and Roth. With a traditional IRA, you can deduct your contributions, depending on your filing status, income, and whether you're covered by a retirement plan at work. When you take withdrawals from a traditional IRA in retirement, the money is taxed, which separates it from a Roth IRA.

With a Roth IRA, you contribute after-tax money, but any withdrawals in retirement (after age 59 1/2) are tax-free. Having the chance for your money to grow and compound tax-free can be one of the biggest blessings for your retirement savings. Using a Roth IRA can easily save you thousands in taxes.

Saving on capital gains taxes

For tax year 2023 (what you'll file in 2024), the maximum you can contribute to a Roth IRA is $6,500, or $7,500 if you're 50 or older. To really see how beneficial a Roth IRA can be, let's look at two scenarios: one where someone invests $500 monthly in a Roth IRA, and one where someone invests $500 monthly in a regular brokerage account.

If both people made those contributions for 25 years and averaged 10% annual returns over that span, they'd have just over $590,000. In those 25 years, both would have personally invested $150,000, meaning around $440,000 would be capital gains.

For the person using a Roth IRA, all $590,000 would be tax-free in retirement. For the person using the brokerage account, they'd owe capital gains taxes on the $440,000. Based on current long-term capital gains tax rates, here's roughly how much a single filer could owe:

Income Long-Term Capital Gains Tax Rate Amount Owed
$0 to $44,625 0% $0
$44,626 to $492,300 15% $66,000
$492,301 or more 20% $88,000

Data source: IRS

Your savings could even venture into the six-figure range depending on how long you invest or how much you manage to make. If you follow the “80% rule” guideline — which says you should aim to have around 80% of your pre-retirement annual income in retirement to maintain your current lifestyle — saving $66,000 or $88,000 in taxes could be a year's worth of retirement income for someone making $82,500 or $110,000, respectively.

Take advantage while you can

One of the downsides of a Roth IRA is the income limit for eligibility. For tax year 2023, here are the income limits to contribute to a Roth IRA:

Filing Status Maximum Income Allowed
Single Less than $153,000
Married, filing jointly Less than $228,000
Married, filing separately Less than $10,000

Data source: IRS

Those who are slightly under these maximum amounts may only be able to make partial Roth IRA contributions.

At some point, you may find yourself over the income limit for a Roth IRA, so it's best to take advantage of it while you can. The great thing is that your money in a Roth IRA will continue to grow and compound even after you're ineligible to make additional contributions. For perspective, a one-time investment can more than 10x in value in 25 years if it averages 10% annual returns.

Because of the low contribution limit, a Roth IRA likely won't be a good primary source of retirement income, but it can definitely be a great supplement to other sources like a 401(k) or Social Security. When it comes to retirement, it's always better to be overprepared than underprepared, and one way to be as prepared as possible is by using all resources you have available to you.

Your future self will thank you for taking advantage of a Roth IRA.

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