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The $65,000 Roth IRA Mistake To Avoid Common Mistakes in Roth IRA Investing Investing in a Roth IRA can be a crucial part of securing your financial future, but it’s essential to avoid common pitfalls that can have significant financial consequences. In this guide, we’ll walk you through these mistakes to ensure you’re on the right track with your Roth IRA investments. Understanding the Basics A Roth IRA is a self-directed retirement account that allows you to contribute after-tax dollars, which are then invested. The key advantage is that the growth of your investments within the account is not subject to taxation. Moreover, when you make withdrawals in retirement, they are also tax-free, provided you don’t attempt to withdraw money before the age of 59.5. Individual Ownership One critical point to grasp is that there’s no such thing as a joint Roth IRA. This means that if both you and your spouse wish to contribute to a Roth IRA, you’ll each have to establish and fund your individual accounts. It’s worth noting that the name “Individual Retirement Account” reflects this individual ownership. Contributions and Income For those who meet the income eligibility criteria, the maximum annual contribution limit for a Roth IRA is $6,500. If both you and your spouse have sufficient earned income, you can each contribute up to this limit. Even if one of you isn’t working but files a joint tax return, the working spouse can contribute to a Roth IRA, and the non-working spouse can contribute to a Spousal Roth IRA. However, remember that these accounts remain the sole property of the individual, legally speaking. Maximizing Contributions It’s highly advisable to strive to max out your Roth IRA contributions each year, if possible. Missing out on contributions for a particular year means you can’t go back and contribute for that year once the time limit has passed. Therefore, maximizing contributions is crucial, and it’s an area where diligent financial planning can pay off in the long run. A Roth IRA Priority In your overall financial plan, consider placing a high priority on maxing out your Roth IRA contributions, right after taking advantage of any employer match and contributing to a Health Savings Account (HSA). This emphasis highlights the importance of this retirement account and the potential long-term benefits it offers. By steering clear of these common mistakes and focusing on sound financial practices, you can harness the full potential of your Roth IRA for a more secure financial future. Remember that it’s a long-term commitment, and making the right choices today can lead to substantial financial rewards down the road.   The Timing of Roth IRA Contributions In the financial world, timing is everything, and when it comes to Roth IRA contributions, getting the timing right can make a significant difference. Let’s delve into the intricacies of when and how you should contribute to your Roth IRA. Priority in Financial Planning First and foremost, it’s essential to understand the priority of a Roth IRA in your financial planning. To put it plainly, it should be near the top of your list, right after two other critical steps: contributing up to your employer’s match in your retirement plan and funding a Health Savings Account (HSA). This prioritization underscores the significance of a Roth IRA in building a secure financial future. Extended Contribution Timeframe One of the unique advantages of a Roth IRA is the extended timeframe for contributions. Unlike other financial accounts, where you typically have until the end of the calendar year to make contributions, a Roth IRA provides you with a generous window. In fact, you have approximately 16 months to contribute for each calendar year. Understanding the Timeframe To illustrate this concept, consider the example of 2023. If we’re currently in 2023, you have the opportunity to contribute from January 1st, 2023, all the way up to the tax-filing deadline for that year, which, in this case, would be April 15th, 2024. It’s essential to grasp that this timeline repeats each year. While the specific tax filing deadline may vary slightly from year to year, the overall principle remains consistent. Brokerage Contributions When you decide to contribute to your Roth IRA, your chosen brokerage will typically inquire about the year to which you want your contribution attributed. For instance, if you use a platform like M1 Finance, they will ask whether you intend for your contribution to apply to the previous tax year (e.g., 2022) or the current year (e.g., 2023). This flexibility is advantageous because it affords you extra time beyond the immediate calendar year to allocate funds to your Roth IRA. An Important Reminder Before we proceed, it’s worth highlighting an often-overlooked step that’s crucial when it comes to Roth IRA contributions – investing the money. It’s surprisingly common for individuals to deposit funds into their Roth IRA and then overlook the critical next step, which is to invest those funds wisely to help them grow over time. Ensuring your Roth IRA contributions are not just sitting idle but actively invested is vital for capitalizing on the account’s long-term growth potential. Whether you have a specific investment strategy in mind or need guidance, making sure your money is working for you within your Roth IRA is key to achieving your financial goals. In the next section, we’ll delve deeper into another mistake many people make when managing their Roth IRAs. But before that, please consider supporting my dog Molly by liking this video and sharing it with anyone who might find this information valuable. The Crucial Step: Investing Your Roth IRA Contributions It’s a story I’ve heard countless times over the years: individuals who diligently contribute to their Roth IRA accounts but somehow forget the critical next step – investing the money. Life’s distractions and our tendency to overlook financial matters can lead to years of inaction, only to realize later that the account hasn’t grown in value. The remedy here is simple: put an end to this oversight by setting up automated investing within your investment account. This ensures that your contributions don’t sit idle but are actively working for your financial future. It’s a small but impactful change that can make a significant difference over time. The Futility of Timing the Market Some might hesitate to invest immediately, hoping to time the market and make their investments when prices are lower. However, attempting to time the market is, for most people, an exercise in futility. Predicting the optimal moment to buy is exceptionally challenging, even for seasoned investors. Therefore, it’s often best to get your money working for you as soon as possible. Choosing Your Investment Strategy If you’re wondering how to invest your Roth IRA contributions, it depends on your financial goals and timeline. For those in the wealth accumulation phase, a two-fund portfolio can be an excellent choice. As you get closer to retirement, or if you’re already there, a three-fund portfolio can offer a more diversified and balanced approach. If you’d like to explore these investment strategies further, I’ve curated a playlist with in-depth explanations of both the two-fund and three-fund portfolios. You can find the link in the video description below. The Flexibility of Roth IRA Withdrawals It’s important to understand that contributions made to a Roth IRA are not locked up until you reach the age of 59.5. Unlike some retirement accounts, you can withdraw the contributions you’ve made before this age without incurring a penalty. However, there’s a crucial distinction: any gains generated within the account cannot be withdrawn penalty-free. For clarity, consider this scenario: if you’ve contributed $6,500 to your Roth IRA, and the account’s value has grown to $10,000, you can withdraw the initial $6,500 without penalty. However, the remaining $3,500 in gains cannot be touched without incurring penalties until you reach the age of 59.5. A Word of Caution on Early Withdrawals Here’s my personal perspective on this matter: while it’s technically possible to make penalty-free early withdrawals from your Roth IRA, I strongly discourage it. Frankly, I believe it’s one of the most ill-advised, irresponsible, and shortsighted financial decisions you can make. To put it into perspective, withdrawing just $6,500 in contributions might cost you $65,000 in potential future investment growth. Before you entertain the thought of dipping into your Roth IRA before retirement, consider what you’d be sacrificing – it could be the equivalent of 7,800 Chipotle burritos, 65 brand-new Apple iPhones, or any other significant purchase. Even the provision for penalty-free early withdrawal of up to $10,000 for a first-time home purchase is, in my opinion, a poor choice. Taking that $10,000 could potentially cost you over $100,000 in future investment growth, given the historical returns of both the housing market and the U.S. stock market. Over the past 12 years, annual home appreciation has averaged around 6.11%, while the U.S. stock market has delivered an average annual return of approximately 12.27%. Rather than depleting your Roth IRA for immediate needs, I strongly advocate leaving your money invested within the account and seeking alternative ways to finance significant expenses, such as purchasing a home. Remember that responsible investing is a long-term endeavor, often spanning five or even ten-plus years. Your Roth IRA is a valuable tool for securing your financial future, so let it grow undisturbed until your retirement years. The Value of Long-Term Investing in a Roth IRA Responsible investing is a patient endeavor, one that requires a commitment spanning five, ten, or even more years. It’s essential to recognize that your money needs time to grow, much like a tree bearing fruit. Withdrawing your contributions prematurely is akin to chopping down that tree before it has a chance to yield its harvest. Once contributions are withdrawn, you can’t replace that money in the future. Emergencies do arise in life, which is why it’s crucial to have an emergency fund set aside for unforeseen expenses. However, under almost all circumstances, it’s imperative not to use your Roth IRA funds for anything other than retirement. Maxing Out Your Roth IRA Before Taxable Brokerage Accounts A common mistake I observe is individuals opting to invest in taxable brokerage accounts before fully maximizing their Roth IRA contributions for the year. From a tax-saving perspective, this can be a significant misstep for some. In a Roth IRA, you invest with post-tax dollars, allowing your money to grow and be withdrawn tax-free in the future. In contrast, taxable brokerage accounts require you to pay taxes on dividend distributions annually, with capital gains tax implications upon withdrawal. Given these differences, it’s ideal to focus on maximizing your Roth IRA contributions, albeit without overextending your risk tolerance. Avoid the temptation of investing in high-risk, speculative stocks or actively managed funds in pursuit of higher returns. These strategies may not be suitable for 99% of investors, including myself. Your Roth IRA is primarily designated for retirement, so consider whether risking the financial well-being of your 60-year-old self is a wise choice when contemplating risky investments. Utilizing the Backdoor Roth for Higher Income Earners Some individuals may find themselves over the income limit for Roth IRA contributions, or they anticipate reaching that threshold in the future as their income grows. In such cases, the backdoor Roth IRA strategy can be employed to harness the benefits of tax-free growth. Here’s a simplified explanation of the process: initially, contribute to a traditional IRA without investing the funds. Subsequently, contact your brokerage to convert these funds into a Roth IRA. The conversion process can be relatively straightforward, and in my experience with M1 Finance, it took just a few days for the funds to move from the traditional to the Roth IRA. However, it’s crucial to evaluate whether this strategy aligns with your current tax situation and long-term financial plans. You have two options to consider: wait until the following January for clarity on your income status, as discussed in a previous point, or contribute to a traditional IRA within the year and perform the backdoor Roth conversion. If your income remains below the limit, there’s no harm done, as you would have paid taxes on the contributions intended for the Roth IRA anyway. Managing Multiple Roth IRAs Across Different Brokerages Many wonder if they can contribute to a Roth IRA through different brokerages, and the straightforward answer is yes. Here’s how it works: you can contribute up to the annual maximum at one brokerage for a given year, such as M1 Finance, and subsequently contribute to another brokerage like Fidelity in the following year. You can continue this pattern, contributing to various brokerages, resulting in multiple Roth IRAs with different providers. Taking it a step further, if you decide that you prefer one brokerage over the others – say, M1 Finance – you can consolidate your Roth IRAs by converting those with Fidelity and Vanguard into your M1 Finance Roth IRA. Additionally, you have the flexibility to split your annual contributions among different brokerages. For example, you could contribute $4,000 to an M1 Finance Roth IRA and allocate the remaining $2,500 to a Fidelity Roth IRA, all within the same year. It’s crucial to be aware, however, that you cannot attempt to circumvent contribution limits by contributing the maximum to multiple Roth IRAs across various brokerages. These accounts are not interconnected, so it’s your responsibility to ensure compliance with contribution limits. Attempting to game the system or exceed these limits may have consequences, so exercise caution. The Bottom Line: Long-Term Investing for Retirement In conclusion, the essence of a Roth IRA lies in long-term investing for retirement. It’s essential to avoid speculative and impulsive decisions, focusing instead on a thoughtful, patient investment approach. A two or three fund portfolio can be an excellent choice for your Roth IRA, offering a diversified and balanced strategy. For those seeking additional guidance and resources, there are numerous free stocks and financial tools available in the video description. Remember, your Roth IRA is a valuable asset for securing your financial future, so approach it with the care and consideration it deserves. Avoid gambling with your investments and prioritize your long-term financial stability. 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