American workers who qualify can contribute as much as $7,000 to a Roth IRA for 2024, with an additional $1,000 catch-up contribution allowed for those age 50 or older. But with no immediate tax benefit, it could be hard for many people to justify maxing out their Roth IRA contributions in 2024 and future years.
However, you might be surprised at what can happen if you pick a brokerage firm to open a Roth IRA and then put in as much as you can this year.
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First, here's what won't happen
As I briefly mentioned earlier, there's no immediate tax break for contributing to a Roth IRA. If you contribute $7,000 to a traditional IRA and qualify for the traditional IRA deduction, you could use the entire amount to reduce your taxable income. Roth IRAs get no such treatment.
However, while traditional IRA withdrawals in retirement are treated as taxable income, Roth IRA withdrawals typically are not. Even if you have $1 million in a Roth IRA, you are free to withdraw the entire amount and the IRS can't touch a penny (although withdrawing as a lump sum is rarely the best idea).
What could happen if you max out your 2024 Roth IRA contribution
Let's say that you're 30 years old and you contribute the $7,000 maximum to a Roth IRA in 2024. Based on the historical average returns of the stock market (about 10% per year over long periods of time), this could grow to about $197,000 by the time you're 65. And that's from maxing out your Roth IRA in one year. (Note: The S&P 500 has averaged a 10.2% annualized return since 1965.)
Of course, there's no guarantee of future investment performance. But the point is that a Roth IRA offers excellent long-term compounding power.
It's also worth pointing out that the deadline for Roth IRA contributions is the same as Tax Day each year in April. So, you can still make 2023 Roth IRA contributions by April 15.
What could happen if you max out your Roth IRA contributions every year?
The previous section discusses maxing out your Roth IRA in 2024. But what if you max your Roth IRA out every year?
Of course, the long-term effects will depend on the exact performance of your Roth IRA investments, the age at which you start, and the age when you decide to retire. But let's look at an example.
Let's say that you're 30 years old and open a Roth IRA in 2024 and fund it with a $7,000 contribution. But you don't stop there. You contribute another $7,000 in 2025, 2026, and so on -- all the way until you're 65 years old and ready to retire.
You might be surprised to learn that at a 10% annualized growth rate, this would lead to a nest egg of nearly $2.1 million by the time you're 65. And best of all, this would be completely tax-free retirement savings. You could choose to withdraw a certain amount of money each week or month to create an income stream, or simply take out money as you need it -- and the IRS won't be able to touch a cent.
Now, this assumes that the maximum Roth IRA contribution will stay at $7,000 forever, when in reality it rises with inflation over time. And it ignores the catch-up contributions you'll be eligible to make after you turn 50. So, the compounding power is likely to be more than the figures discussed here.
Other Roth advantages
Now, $7,000 might seem like a large portion of your income to tie up until you reach retirement age, especially if you're young. After all, what if you don't have an adequate emergency fund set up yet? Or what if you also plan to buy a house eventually and are concerned about your down payment?
If you're concerned about keeping your money in the Roth IRA until retirement, it's important to realize that Roth IRAs have a special provision that allows you to withdraw your contributions (but not your investment profits) at any time, and for any reason, without penalty. Of course, the best compounding power comes from leaving your money in the account. But if you are faced with a true financial emergency, you can choose to take some of your money back.
Also, IRAs in general have a special rule that allows you to take as much as $10,000 out of your account to use toward a first-time home purchase (I did this about 15 years ago), or any amount to help pay for college expenses for you or someone else.
In short, when you put money into a Roth IRA, it isn't as "tied up" as you might think. So don't let this stop you.
The bottom line
Maxing out your Roth IRA might seem undesirable since you don't get any immediate benefit for doing so, but the long-term effects can be outstanding. And unlike building up a million-dollar nest egg in a traditional IRA, you can use your Roth IRA to produce tax-free income.
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Here's What Happens When You Max Out Your Roth IRA Contributions was originally published by The Motley Fool
