Average Roth IRA Returns

Point of Interest

Planning for retirement with a Roth IRA is a great way to take advantage of tax advantages provided by the IRS. 

Roth IRAs provide a unique, tax-advantaged way for people to save for retirement. Introduced in the late 1990s by the Taxpayer Relief Act, Roth IRAs have grown in popularity over the last two decades amongst savers in all stages of the retirement saving process. When deciding to take advantage of these types of accounts, you’ll want to understand how they work, what levels of return you should expect and how to maximize your Roth IRA return rate.

What is a Roth IRA?

An Individual Retirement Account (IRA) is an investment medium designed to be used for retirement savings that offer users tax benefits. A Roth IRA, named after Senator William Roth of Delaware, is a variation of the traditional IRA created in 1997. The key differences between the two types of accounts are who is eligible to contribute to each and when you’ll be able to realize the associated tax benefits.

How does a Roth IRA work?

A Roth IRA is a retirement saving investment account that you’re able to contribute to every year. With a traditional IRA, you don’t pay taxes on the money that you put into the account until you withdraw it during retirement. With a Roth IRA, though, you will pay taxes on the money when you contribute. However, when you withdraw the money, you will pay no taxes. In other words, the tax benefit on traditional IRAs is immediate, while the benefit for Roth IRAs is realized later.

The IRS has specific guidelines about who is allowed to contribute to a Roth IRA and how much money they’re able to contribute annually. For those who are within the required income brackets, maximum contributions limits are $6,000 annually for those under the age of 50 and $7,000 for those 50 and older. As mentioned, these contributions for a Roth IRA are not tax-deductible as you’re choosing to realize the tax benefits during withdrawal.

Roth IRA holders can withdraw money from their IRA at any point in time tax and fee-free up to the amount they have invested. For account earnings, though, there are limitations. Violating these limitations is possible, but will come with a 10% penalty. Earnings can’t be withdrawn until they have been in the account for at least five years. Additionally, the account holder must either be at least 59 ½ years old, using the funds for the purchase or rebuilding of a first-time home or if the account holder has become disabled.

Compounding: How a Roth IRA earns interest

A Roth IRA is an account type that holds other investments like stocks, bonds, mutual funds, CDs, etc. These different investment types each have a unique way they earn money, but they all take advantage of compounding. Compounding is a term that refers to an increased potential for profits due to prior interest earnings.

For example, if you have $1,000 in an account that is earning 10% interest, you can expect to make $100 in profit this year. Would you expect to make that same $100 next year? Not with compounding. If you’re able to reinvest those profits (which most financial accounts do automatically), you’ll start next year with $1,100 in your account. 10% of $1,100 is $110. Because of previously earned interest, you’re now able to make more money. After year two, you’ll have $1,210 in the account. 10% of that for next year is $121.

The compounding process continues for the life of the investment medium. Compounding is the reason to begin saving for your retirement as early as possible is advised. Smart investments can see much higher Roth IRA return rates when given ample time to grow.

What is the average Roth IRA return?

It’s important to know that Roth IRAs are made up of different investment products that each carries varying levels of risk and rewards. These different investment products have the potential to increase and decrease in earnings. That being said, financial advisors follow similar plans when creating the risk profile for Roth IRA accounts. What this does is generate returns that often fall into the same window.

Historically, Roth IRAs return somewhere between 7% and 10% annually. Depending on market conditions and the level of risk you accept, your actual returns could be higher or lower than this. Many investment advisors tailor Roth IRA plans based on how far out you are from retiring. If you are very far out, you may be able to take on more risk for the potential of higher gains. If retirement is close, a higher risk is something you probably can’t afford.

Tips for maximizing your Roth IRA returns

There are several great strategies and tips you can employ to get the best Roth IRA return rate. First, get time on your side. Even if you’re only able to make small contributions now, let the effects of compounding begin to work for you.

Second, contribute regularly. Retirement savings are not created overnight; they are grown. If you can develop good financial discipline through regular contributions, you’ll set yourself up for success.

Make sure you take the time to look at the investments in your Roth IRA. There’s a tendency to think all retirement accounts are created equally and are devoid of risk. This is not the case. Treat your Roth IRA just like you would any investment account. Even if you’re using a professional to manage your retirement, you should be aware of what you’re invested in, the level of risk associated, and the expected rates of return.

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