Want to lower the amount of taxes you need to pay in retirement? Then leveraging a retirement account like a Roth IRA might be an excellent strategy to use.
Roth IRAs are individual retirement accounts with a unique tax advantage: Your contributions going into the account are taxed, but you can withdraw that money in retirement tax-free. This is a nice way to balance out the tax-advantaged accounts you may already have, including the popular traditional 401(k) at work, which is tax-deferred.
But Roth IRAs come with a few limitations, and one of the biggest is the fact that you can only contribute so much to these accounts per year. Still, it’s possible to rack up a whopping $1 million in a Roth — and you can do it within your working career if you start early. Here’s how.
First, Make Sure You Can Contribute to a Roth IRA
Before you get too excited about saving $1 million with a Roth, make sure you actually have access to this particular savings vehicle. Not everyone does, due to income limits and contribution phaseouts. Here’s how those numbers break down for 2018:
- If you’re single, you can’t contribute directly to a Roth if you make over $135,000. The phaseout of your contributions starts at $120,000.
- If you’re married filing jointly, you start hitting phaseout limits once your modified adjusted gross income (MAGI) stands at $189,000. Once you earn $199,000 or more, you can’t contribute directly to a Roth.
You have until this year’s tax filing deadline, which is April 15, 2019, to complete your contributions for 2018. Here are the updated income limits for 2019:
- If you’re single, your AGI must be under $137,000. Once you have $122,000 worth of AGI, the contribution phaseout rules kick in and you can make contributions but not the full amount.
- If you’re married and file jointly, your MAGI must be less than $203,000. Your contribution phaseout begins at $193,000.
Over the Limit? Consider a Backdoor Roth Conversion
This doesn’t mean you can never contribute to a Roth IRA. But the process is no longer so straightforward if you want to continue taking advantage of this type of account. If it makes sense for you and your situation, you could do a backdoor Roth conversion (opens in new tab).
Here’s a (very simplified) explanation of how a backdoor Roth conversion works, from my free ebook, Going Beyond Simple Money (opens in new tab):
You contribute money to a traditional IRA (which doesn’t have an income limit). At some point afterward, you can then convert the funds in your traditional IRA into a Roth IRA. It’s best to talk to your financial planner to determine your best course of action if you make too much to contribute to a Roth but want to leverage this particular retirement savings tool.
If You Can Contribute to a Roth, Here’s How to Fill It with $1 Million in Less Than 40 Years
Let’s assume you can contribute to a Roth IRA. If you do so consistently, it’s possible to accumulate $1 million in 38 years in this account.
How? By consistently contributing the maximum amount to your account each year you earn income during your working years. For 2018, you can contribute up to $5,500 if you’re under 50. If you’re 50 or older, you can add an additional “catch-up contribution” of $1,000.
If you haven’t contributed the max to your account for 2018 yet, you still have time to do so — and in fact, you have until the tax filing deadline in April 2019 (opens in new tab) to finish contributing cash to your Roth IRA for the 2018 tax year.
And in the 2019 tax year, the IRS is giving savers a little extra opportunity to get to that $1 million mark sooner: For the first time in six years, the IRS increased the contribution limits for IRAs, including Roths. In the new year, you can contribute up to $6,000 if you’re under 50. For those 50 and older, you can contribute up to $7,000 per year.
But even with these increased contributions, it doesn’t take a math whiz to realize it would take you 166 years to get to a million bucks in your Roth if you put in the max of $6,000 per year. Not exactly a great retirement plan … and certainly not in line with what I told you above, so what’s the tick?
The Power of Compounding — and Why You Need to Act Now If You Want $1 Million in Your Roth IRA
If you want to save $1 million in 38 years in a Roth IRA, you need a combination of factors:
- Regular monthly contributions ($500 per month will allow you to max out your Roth in 2019) that you make every month.
- A reasonable rate of return from the market, which you can expect if you invest strategically in a well-diversified, low-cost portfolio of funds.
- Commitment to leave your money invested in the market, without getting spooked by market volatility or succumbing to the temptation to remove money from your Roth to use on other things throughout your lifetime.
Of all of these, time is one of the most important. The more time you give your money to stay invested in the market, the more you allow compounding returns to work to your advantage.
You get compounding returns when money you invest earns a return, and then that money (if you leave it in the Roth) starts earning a return. Thus, your returns begin to compound … and has the power to get you to a million dollars in wealth.
The more time you give your money in your Roth to earn compounding returns, the less you’d need to save each month to eventually hit a million dollars. Saving the maximum amount of $500 per month for 38 years would get you there if you start in your mid-20s. You’d be a Roth IRA millionaire at 63 (a few years before full retirement age), assuming you earned a 7% annually compounded return. To be exact, you’d accumulate $1,035,366.12.
You could easily argue that while 7% is a reasonable historical rate of return, today’s investors should expect lower returns from their investments. Assuming you only earned a 6% return, it would take you a little over 41 years to hit the million-dollar mark. And if you only earned 5%, it would take you about 46 years to get there.
In addition, these simple calculations don’t take sequence of returns into account. Most calculators — even ones that show compound returns — are linear and will give you what the average of a 7% annual rate of return does for your money. But in the real world, the order in which you earn returns each year matters (opens in new tab) and affects the final outcome.
That’s why a better analysis may be to do a Monte Carlo simulation, or to work with a financial planner who can run advanced projections through specialized software to show you the probabilities of reaching your goals based on the facts of your current situation.
How to Get to $1 Million Even Faster
You may also simply want to get to $1 million in money you can use for retirement sooner than 38 years — and that’s certainly possible to do. You’ll just need a combination of savings and investment vehicles to do it, rather than relying on a Roth alone.
Here are some options to consider:
- Your 401(k) or other employer-sponsored retirement plan (like a SIMPLE IRA or 403(b)). If your employer offers a match, contribute enough to get the full contribution from your company.
- A pension program if you have access to one.
- You may be able to contribute to a SEP IRA if you are self-employed or earn 1099-MISC income on the side of your day job.
- An HSA might be an excellent tool to use because of its triple tax advantage. (Here’s how my wife and I leverage HSAs (opens in new tab) as part of our retirement savings plan.)
- Any equity compensation you may receive, like stock options or RSUs.
And of course, there’s always a plain old brokerage account. While these investment vehicles don’t have any particular tax advantages like 401(k)s or Roth IRAs do, they do offer a lot of flexibility in how you can use the money you invest here (whereas retirement plans often come with rules about when and how you can withdraw your funds).
Outside of accounts, think about other ways you could invest to fund your retirement. That might include starting your own business with plans to sell it down the road or investigating opportunities in real estate if being a landlord might make sense for you.
There are a lot of options for accumulating $1 million or more to use to fund your eventual retirement. The key is to keep your eyes open to the possibilities, take advantage of opportunities, and create a strategic plan that ties all these things together.
Eric Roberge, CFP®, is the founder of Beyond Your Hammock (opens in new tab), a financial planning firm working in Boston, Massachusetts and virtually across the country. BYH specializes in helping professionals in their 30s and 40s use their money as a tool to enjoy life today while planning responsibly for tomorrow.
Eric has been named one of Investopedia's Top 100 most influential financial advisers since 2017 and is a member of Investment News' 40 Under 40 class of 2016 and Think Advisor's Luminaries class of 2021.