If you want to retire a millionaire, IRA funding is a great place to start. IRAs or individual retirement accounts are an invaluable investment tool as they benefit from taxes. In addition, because they are created and funded by you as an individual, you can save for retirement regardless of your employer.
Whether you’re funding a Roth IRA, a traditional IRA, or a combination of both, you’re eligible to contribute up to $ 6,000 a year in 2020. If you’re 50 or older, you can make an additional $ 1,000 catching-up contribution, so your limit is $ 7,000. Here’s how long it will take you to become a millionaire if you increase your IRA each year using the 2020 limits.
How long does it take to become a millionaire in the IRA?
Suppose you start increasing your contribution each year at the age of 22, with an average cost of $ 500 at the beginning of each month. You earn an annual income of 8%, which is slightly below S&P 500 on average after inflation for the last 40 years.
You would reach the status of a millionaire at the age of 55 after 33 years and four months of contributions. This also implies that you did not make $ 1,000 catch-up payments when you turned 50. Of course, this uses the limits for 2020. They are adjusted for inflation in steps of $ 500, so it is safe to say that you will you can contribute more over time – although you will have to save over $ 1 million to have the same purchasing power that a $ 2020 millionaire would have.
It is also important to keep in mind that the 8% return estimate is based on the average annual return of the S&P 500 from 1980 to 2020. Past performance does not guarantee future performance. The level of risk you take when investing also has a major effect on your return.
Roth vs. Traditional IRA: That makes a big difference
Becoming a Roth IRA millionaire is very different from becoming a traditional IRA millionaire. With a Roth IRA, you cannot deduct your tax contributions. But the money is 100% tax-free when you withdraw it after you turn 59 1/2 years old, provided you have had the account for five years. (You can withdraw contributions, but not income, whenever you want, without paying taxes or penalties.) The traditional IRA gives you a pre-tax deduction of your contributions in most cases. However, you still owe income taxes when you withdraw your money into retirement.
In short, being a Roth IRA millionaire means you have $ 1 million in retirement alone. Being a traditional IRA millionaire means you have $ 1 million, but the IRS will still demand a reduction.
If you expect to be in a high tax category when you retire or worry about raising tax rates, choosing Roth instead of the traditional IRA makes sense, provided you qualify based on the income constraints of the Roth IRA. If you earn too much to fund Roth, you can use a strategy called backdoor IRA, where you fund a traditional IRA and then convert it to Roth. You later pay all applicable taxes in exchange for this non-taxable nest.
Do you need to increase your IRA?
If your employer offers a 401 (k) match, contribute enough to get the full match before funding your IRA. Paying off high-interest credit card debts and building an emergency fund that can cover you for three to six months at first are also good moves.
Once you do these things, strive to maximize your contribution to the IRA. You will have many more investment opportunities and overall flexibility because you control the account, not your employer.