Roth IRA: A Simple Guide

A Roth IRA is a retirement savings account that you fund yourself, designed to help you build a nest egg for your future. Unlike some other retirement plans, it has unique tax advantages that make it appealing for many people.

Key Features:

Contributions: You put in money that you’ve already paid taxes on (called “after-tax dollars”). For 2023, the contribution limit is:

$7,000 per year if you’re under 50 years old.
$8,000 per year if you’re 50 or older.

These limits can change over time, so it’s a good idea to check the current rules. You can contribute any amount up to the limit each year—it’s flexible!

Tax Benefits: Here’s where the Roth IRA stands out:

Your contributions don’t reduce your taxable income in the year you make them (unlike a traditional IRA or SEP IRA).
However, the money in your Roth IRA grows tax-free, and when you take it out in retirement, you don’t pay taxes on qualified withdrawals—including the growth! To be “qualified,” withdrawals typically need to happen after age 59½, and the account must have been open for at least 5 years.

Growth and Investments: The money you put into a Roth IRA can be invested in various options, like stocks, bonds, mutual funds, or even annuities (more on those later). How your account grows depends on what you invest in. Note: If you invest in things like stocks, the value *can* go down if the market dips—there’s no automatic protection against losses unless you choose specific investments with guarantees.

Withdrawals: When you’re ready to take money out in retirement (after age 59½ and meeting the 5-year rule), the withdrawals are tax-free. This includes both your original contributions and the earnings, as long as the rules are followed.

Example: Helen’s Story

Helen is 40 years old and works as a self-employed gig worker, driving for Uber, delivering for Amazon, and tutoring on the side. She earns about $50,000 per year and has been worried about not having a retirement plan. Let’s see how a Roth IRA could help her:

Helen decides to open a Roth IRA and contributes $7,000 per year, the maximum allowed for her age.

She pays taxes on her full $50,000 income first, then uses some of that after-tax money to fund her Roth IRA. (So, her taxable income stays $50,000—it doesn’t drop to $43,000 like it might with a traditional IRA.)

Over the years, her $7,000 annual contributions grow tax-free. For example, if she invests it wisely, it could grow significantly by the time she retires.

When Helen is over 59½ and starts withdrawing money (assuming her account is at least 5 years old), she won’t owe any taxes on what she takes out. This could provide her with a solid, tax-free nest egg for retirement.

Note: If Helen used a traditional IRA instead, she might lower her taxable income to $43,000 in the year she contributes, but she’d pay taxes on withdrawals later. With a Roth IRA, she gets the tax break in retirement instead.

Fixed vs. Indexed Annuities: Growing Your Savings

Annuities are financial products you can buy to grow your savings and, often, provide income in retirement. They can be used on their own or as an investment option inside a Roth IRA. Here’s a breakdown of two common types:

Fixed Annuities

How They Work: You give your money to an insurance company, and they promise to pay you a fixed interest rate over time. It’s predictable and steady.

Guarantees:  They also come with a guaranteed minimum interest rate, so even if rates drop, your money will still grow at least by that minimum amount.

Best For: People who want safety and don’t want to worry about market ups and downs.

Indexed Annuities

How They Work: Your returns are linked to the performance of a market index, like the S&P 500. However, you don’t directly invest in stocks—it’s more like your gains are tied to how the index does.

Upside Potential:   If the index performs well, you can earn more than with a fixed annuity (though there’s usually a cap on how much you can earn).

Downside Protection: If the index goes down, you don’t lose money. Your account value stays the same—no interest is added that year, but your principal is safe thanks to a 0% floor.

Best For: People who want a chance at higher returns but still need protection from market losses.

Using Annuities in a Roth IRA

You can choose to invest your Roth IRA money in an annuity. Here’s what to know:

Taxes: Since a Roth IRA already offers tax-free growth and withdrawals, an annuity inside it doesn’t add extra tax benefits. Instead, focus on the annuity’s other features—like guaranteed growth or income options—when deciding if it’s right for you.

Withdrawal Rules:  If you take money out of your Roth IRA (including from an annuity) before age 59½, you might face a 10% federal tax penalty, unless an exception applies. Plus, if the withdrawal isn’t qualified, you could owe taxes on any earnings.

Putting It All Together

A Roth IRA is a great option for self-employed people like Helen who want tax-free money in retirement. You fund it with after-tax dollars, and it grows without tax worries

Annuities (fixed or indexed) can be part of your Roth IRA strategy, offering guaranteed growth or protection from market dips, depending on what you choose.

When planning, think about your goals: Do you want safety (fixed annuity), some growth potential with protection (indexed annuity), or something else entirely? Your Roth IRA lets you customize your investments to fit your needs.