IRA stands for Individual Retirement Account, and it’s an account that, well, allows you to individually invest in your retirement account. In total, more than about 42.4 million US households own traditional or Roth IRAs, with 19% of those being Roth IRAs.
What’s the difference, you ask? We go over the basics of Roth IRAs here, but the main difference between the two is how you’re taxed. With a Roth IRA, contributions are not tax-deductible. However, as a trade-off, your contributions grow tax-free, and once you’re in retirement, you can withdraw your contributions tax-free, as well.
So, how does the account grow? How much interest does a Roth IRA earn? Let’s dive into that.
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What is a Roth IRA?
While most people have heard of both Roth and Traditional IRAs, there are actually quite a few other types of Individual Retirement Accounts, including SIMPLE IRAs, SEP IRAs, and more. While they’re pretty similar, the main difference between the accounts are the various tax advantages.
As mentioned above, with a Roth IRA, contributions are not tax-deductible. However, as a trade off, your contributions grow tax-free, and once you’re in retirement, you can withdraw your contributions tax-free, as well.
Roth IRA vs. Traditional IRA
A Roth IRA is different from a traditional IRA in that when you pay into a traditional IRA, your contributions are deductible on your current tax return. However, once you withdraw your contributions in retirement, they will be subject to taxation based on the tax bracket you’re in during retirement.
If you’re wondering what the major differences are at the moment, there really aren’t any massive differences outside of how you’re taxed.
It is worth mentioning, though, that if your retirement is decades away, you will gain more tax benefits with a Roth IRA if you have a few decades before you retire. This is because the Roth IRA has five years of contributions which must be met before it can provide tax-free withdrawals during retirement, while a traditional IRA doesn’t have this requirement.
How Does a Roth IRA Grow?
When you invest in a Roth IRA, it grows via two methods: contributions and earnings. As you continue to contribute to your account over the years, it obviously grows in terms of the balance. However, there is also the potential to earn compound interest on the money that is there. Just how much it can grow really depends on the investments you’ve made within the account.
When you’re deciding what to invest in with your Roth IRA account, you’ve got tons of options. The only things you can’t invest in are collectibles and life insurance. Generally, the best options for Roth IRA investments are the ones that generate highly taxable income, typically in the form of short-term capital gains or dividends and interest.
How Does a Roth IRA Earn Interest?
Retirement accounts, including Roth IRAs, earn compound interest. It’s why we’re such a big supporter of starting to invest as early as possible, and it’s one of the main ways in which retirement accounts grow wealth. However, if you’re looking for a simple answer: most Roth IRAs earn about 7-10% each year.
How much money is that overall? Let’s say you make the standard $6,000 contribution every year for 10 years at a 10% interest rate. After 10 years, you would have a total of just over $95,000 in that account.
Compare that to saving $6,000 a year in a regular bank account, which wouldn’t be earning compound interest. You’d have a mere total of $6,000. You’ve earned $35,000 by doing nothing more than investing that money in a different type of account. See why compound interest is so great?
How to Maximize Your Roth IRA Investments
So how can you ensure you’re maximizing your Roth IRA investment returns? One of the best ways to make your money grow is through diversification. That’s a rule that applies to any type of retirement account or investment strategy you use.
However, outside of that, you can also:
- Make equal monthly contributions (also known as DCA, or dollar-cost averaging) so that you can take the guesswork out of timing your investments just right.
- Consider investing in individual stocks instead of mutual funds.
- Make contributions at the start of the tax year to take advantage of compound interest for as long as you can!
Want more personalized suggestions for how to grow your retirement account? If you’re a small business owner, get in touch with us so that we can help you learn more about what your options are for you, your business, and your employees.
Invest with Wealth Stack: Managed IRA Plans
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Wealth Stack has plenty of tools at your disposal, including providing access to financial counselors who will walk alongside you and your workers as they educate themselves about all aspects necessary when investing in their retirement portfolios. And, Wealth Stack retirement accounts, which are SIMPLE IRA plans, are managed by an expert investor and former hedge fund manager.
Not only that, but we also:
- Take care of the paperwork and direct deposit setup for you
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