In the past month I have helped two friends open their very first Roth IRA’s. Both of my friends were in their mid 30’s. Both friends had put it off for years because they didn’t know where to start. The path of least resistance was to do nothing. They should have probably started their IRA’s a decade earlier, but I’m hear to tell you, it is never too late to get started.
So what is a Roth IRA anyway? Simply put, it is a retirement account, funded with after-tax dollars, that grows tax free. The Roth IRA was established by the Taxpayer Relief Act of 1997. Senator William Roth of Delaware is credited with sponsoring the bill. With decades of tax free growth and the power of compounding interest you could become a millionaire. In 1997 the contribution limit was $2000 and today has grown to $5500. The limit is occasionally raised based on inflation.
The top 4 reasons you should open a Roth IRA today.
- A Roth IRA is not tied to your employer. You can change jobs without the hassle of having to transfer accounts. As you move along in your career you may change jobs several times. That usually means a new 401k with each new employer. Before long you have several ghost 401k’s. Not so with the Roth IRA.
- All market returns and dividends grow tax free. You might think that if your 401k account balance reads $100,000 it is all yours. Nope. Don’t forget Uncle Sam. The government will take somewhere between 15-35%. In addition there may be state taxes as well. So your $100,000 account balance might be worth only $75,000. Bummer huh!
- You can control your fees. This is where things get exciting. You see nothing is free and index funds and mutual funds are no different. These fees are called expense ratios. Every index fund or mutual fund has one. Your goal is to find the smallest expense ratio possible. Contrary to what you may think, there is no correlation between what an index fund charges and the returns it generates. So for example, my favorite index fund for a Roth IRA is VTSAX. It has an expense ratio of 0.04%.
- You get to decide what investments go into your Roth IRA. For your employer 401k, your investment choices are limited to what your employer allows you to invest in. Sometimes this can mean high fee funds or poorly thought out investment options. But with a Roth IRA the investment choices are nearly limitless.
Where to go to open your Roth IRA
My top three locations to open your Roth IRA online are Vanguard, Charles Schwab, and Fidelity. I personally use Vanguard and Charles Schwab, so I will focus on these two brokerages. Think of Vanguard as a co-op or credit union where the investors own the company. Vanguard is not a publicly traded and thus has no need please share holders. On the other hand Charles Schwab is a publicly traded company that has a mission to offer low cost brokerage services to clients. Charles Schwab aggressively competes on reducing expense ratios for their funds with Vanguard and Fidelity. Usually once a year one of these companies announce that they are lowing fees on their funds and the other companies will follow suite.
So there you have it. The top 4 reasons you should open a Roth IRA today. No more procrastinating. Go online and open that Roth IRA. In a future post I plan a step by step tutorial to get you through the process of opening up your Roth IRA.
If you have questions or ideas for future posts leave me a comment. Together we can retire early.
*Full disclosure. I own Vanguard and Charles Schwab funds in my Roth IRA and taxable accounts. I was not paid in any way for this post. Just trying to share my love for low cost index funds.