Do you want to retire wealthy and pay no taxes? Listen up.
Americans are great at many things, but saving for retirement isn’t one of them. According to the Federal Reserve’s Survey of Consumer Finances, the median American household aged 65 to 74 has just $200,000 saved for retirement.
I don’t wish this financial fate on my loved ones or myself, so I’m doing something about it while I still have time. The good news is that you likely still have time, too. So let’s walk through this together.
I’ve crafted a simple plan to build a $1 million retirement nest egg that almost anyone can follow. Here’s how I plan to retire as a millionaire and pay no taxes.
Step 1: Open a Roth IRA
Various investment accounts can help you save for retirement, but I’m going to skip right to opening a Roth IRA. It’s an individual retirement plan with special rules to help you maximize your savings. Here are the basics.
You can open a Roth IRA with almost any brokerage of your choice. Once it’s open, you can contribute up to $7,000 in 2024, and the amount typically stays the same or rises every tax year. When you turn 50, you get to make a catch-up contribution of an additional $1,000, bringing the total to $8,000.
Roth IRA contributions aren’t deducted from your taxable income. In other words, you’re putting take-home money into your Roth IRA. The beauty of that is you don’t pay taxes on your distributions in retirement. And that includes your investment gains!
No taxes can mean saving tens or even hundreds of thousands of dollars in your nest egg over the years. It’s such a sweet deal that the government limits how much you can contribute. The rules also bar high earners from contributing to a Roth IRA. However, there are exceptions and ways to get money into a Roth even for those with high incomes.
Step 2: Max it out without fail
Consistency is the key to getting the most out of your Roth IRA. You should max out your Roth IRA contributions every year, if at all possible. Life happens, and scrambling to cover an unexpected expense isn’t fun. However, forgoing your contributions can cost you later in life.
Remember that Roth IRAs have contribution limits. Catching up later is hard because you can’t invest more to compensate for the missed years. The rules give you an extra $1,000 once you turn 50, but that won’t make up for missing an opportunity to get $7,000 into a Roth now.Â
Maxing out your Roth IRA, especially in your early years, will ensure that compounding does most of the heavy lifting for you.
Step 3: Play it safe
Roth IRAs give investors a bit of flexibility. You can own individual stocks, mutual funds, bonds, exchange-traded funds, certificates of deposit, and money market accounts inside a Roth IRA. Since your money grows tax-free, it can be tempting to swing for the fences in the hopes that you strike it big.
The downside is that you have limited ability to make up for steep losses that could set you back years’ worth of contributions. If you suffer a big loss in a Roth, you can’t just contribute an unlimited amount of additional funds to make up for it.
Because of that, I suggest that you focus more on broadly diversified stock exposure that can help reduce the size of losses, even if it means missing out on maximum gains. That doesn’t mean you should keep your money in cash, though. Consider exchange-traded funds that track the broader market, which has historically returned between 9% and 10% annually. That’s plenty to make you very wealthy over time.
Here is what the results might look like
I’m currently 35, which gives me approximately 30 years until entering the age bracket cited in the survey. I plan to dollar-cost average into a fund that tracks the S&P 500, like Vanguard‘s S&P 500 ETF.
Suppose I successfully max out my Roth IRA every year until I’m 50. Assume that my returns average 9% annually, comfortably within the market’s historical averages.
My Roth IRA would be worth approximately $397K by age 50. Then, I would increase my annual contributions to $8,000 to continue maximizing them. By age 65, my portfolio should be worth approximately $1.6 million. This doesn’t even include any potential increases in the contribution limits, which are highly likely over the next several decades.
This example shows what a 35-year-old person can amass with three decades and a plan, and people even younger have a tremendous opportunity ahead of them.
Older than me? Don’t feel discouraged! There’s still time to build substantial wealth. You could start from zero at age 50 and still turn 65 with more money saved than the median household in America.
The key takeaway? Get started. The rest is simple.