The money in the account continues to grow even without the owner making regular contributions. Unlike traditional savings accounts that have their own interest rates that periodically adjust, Roth IRA interest and the returns account owners earn depend on the portfolio of investments.
Roth IRAs grow through compounding, even during years when you can't make a contribution. There are no required minimum distributions (RMDs), so you can leave your money alone to keep growing if you don't need it.
Fully fund a Roth IRA every year, build a diverse portfolio, and you can become a millionaire in time for retirement. As long as you start early enough.
Your Roth IRA Can Grow, But Not Forever.
How much will a Roth IRA grow in 20 years? While a $6,000 initial deposit in a Roth IRA can grow to $23,218 in 20 years at a 7% annual rate of return, it will grow much more if you continue to make monthly or yearly contributions to the Roth IRA.
Because the maximum annual contribution amount for a Roth IRA is $6,000, following a dollar-cost-averaging approach means you would therefore contribute $500 a month to your IRA. If you're 50 or older, your $7,000 limit translates to $583 a month.
Key Takeaways
One key disadvantage: Roth IRA contributions are made with after-tax money, meaning that there's no tax deduction in the year of the contribution. Another drawback is that withdrawals of account earnings must not be made until at least five years have passed since the first contribution.
Start saving as early as possible, even if you can't contribute the maximum. Make your contributions early in the year or in monthly installments to get better compounding effects. As your income rises, consider converting the assets in a traditional individual retirement account (traditional IRA) to a Roth.
Typically, Roth IRAs see average annual returns of 7-10%. For example, if you're under 50 and you've just opened a Roth IRA, $6,000 in contributions each year for 10 years with a 7% interest rate would amass $83,095. Wait another 30 years and the account will grow to more than $500,000.
Roth IRAs are a popular retirement account choice for a reason. It's because they're easy to open with an online broker and historically deliver between 7% and 10% in average annual returns. Roth IRAs harness the advantages of compounding, which means even small contributions can grow significantly over time.
In many cases, a Roth IRA can be a better choice than a 401(k) retirement plan, as it offers a flexible investment vehicle with greater tax benefits—especially if you think you'll be in a higher tax bracket later on.
Key Takeaways
Contributing as much as you can—at least 15% of your pre-tax income—is recommended by financial planners. The rule of thumb for retirement savings says you should first meet your employer's match for your 401(k), then max out a Roth 401(k) or Roth IRA, then go back to your 401(k).
Specifically, ProPublica found that Buffett has $20.2 million in his Roth IRA at the end of 2018, while his top lieutenant at Berkshire Hathaway, Buffett's holding company, has even more in a Roth -- $264.4 million.
A general rule of thumb is to have one times your annual income saved by age 30, three times by 40, and so on.
By age 25, you should have saved at least 0.5X your annual expenses. The more the better. In other words, if you spend $50,000 a year, you should have about $25,000 in savings. If you spend $100,000 a year, you should have at least $50,000 in savings.
The Bottom Line
If you have earned income and meet the income limits, a Roth IRA can be an excellent tool for retirement savings. Once you put money into a Roth, you're done paying taxes on it, as long as you follow the withdrawal rules.
You have until the tax filing deadline each year to open a Roth IRA and make contributions for that tax year. So the best time of year to open a Roth IRA could be April if you're trying to score some last-minute tax benefits for the future.
Stocks also grow IRAs through dividends and increases in the share price. While no one can predict the future, the annual range of return for stock investments has historically been between 8% and 12%.
IRA Millionaire: A Detailed Breakdown
If you contribute this year's IRA maximum of $6,000 every year and earn a 7% average annual return on investment (ROI), it would take a little more than 37½ years to grow your account to $1 million.
But even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circumstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.
Roth IRA contributions are especially liquid and can be withdrawn at any time and for any reason without taxes or penalty, and investors may also withdraw the investment-earnings component of their IRA money without taxes and/or penalty under very specific circumstances.
Retirement-plan provider Fidelity recommends having the equivalent of your salary saved by the time you reach 30. That means if your annual salary is $50,000, you should aim to have $50,000 in retirement savings by 30.
Despite rules designed to limit IRA contributions by the wealthy, almost 29,000 Americans hold these giant accounts, and nearly 500 of them somehow managed to get $25 million or more into their IRAs.
Many wealthy people use true self-directed IRA (or 401k) accounts to accumulate multimillion-dollar retirement portfolios. These are unlike the self-directed plans most people have. Instead, the wealthy use self-directed retirement plans to invest in non-traditional investments.