Similar to other IRAs (Individual Retirement Account) such as traditional IRAs or an employer-sponsored retirement plant, Roth IRA accounts allow for investments that are eligible for interest to add to the growth of your retirement account. After selecting an asset to invest in, it’s important to understand that the interest on your retirement plan as an investment grows not just over time but in two additional ways. To learn more about this process and understand how interest works for your savings inside an IRA plan, read on below.
How Roth IRA Interest Rates Work
In this article:
The Growth of Your Retirement Account
The primary source of growth in your Roth IRA comes from your Roth IRA contributions. Be sure to consider that the contribution limits only increase in a year if the inflation has a cumulative effect since the last adjustment was higher than $500. Also, Roth IRAs do not require minimum distributions or have minimum amount that you are allowed to withdraw from your account.
There are also other factors such as using your Roth IRA to invest in mutual funds or an IRA CD (certificates of deposit) that contribute to your financial success. Also, the potential for your retirement account to gain interest and compound interest are two major forces working for your continued financial security. To further understand how Roth IRA interest rates contribute to your long-term financial wealth, we’ve broken down the specifics of the two types of interest.
The beauty of compound interest is that it continues to build on itself which increases your account balance annually. You can simply think of it as gaining “interest on interest.” The higher the numbers, the greater the compound interest. For example, if your opening balance is $10,000, your interest at 5% is $500. This gives you a closing balance of $10,500 for the year. In the following year, your $10,500 will have an interest at 5% of $525. This will give you a new closing balance of $11,025. These numbers will continue to get larger and larger.
Whether you have a Roth or traditional IRA, the income on your account will continue to grow even if you stop contributing. For those who are age 50 and above by the end of the calendar year, you can make a catch-up contribution annually. The only difference is that with a traditional IRA, there is a tax deduction when you make your withdrawals later. This means you will need to pay an income tax. Also, you can take note of the marginal tax rate for your taxable investments or consult with a tax advisor for the updated figures.
Simple interest is easier to calculate than compound interest. Understanding how your money grows requires learning how interest-bearing assets in Roth IRAs differ from other options. The basic concept of simple interest is the interest gained from your overall contribution.
For example, if you are making IRA contributions of $3,000 annually, you will only earn an interest of $5,000 for 20 years. This only gives you a total balance of $65,000 during the 20th year. However, just like compound interest, your retirement account will also continue to grow even after you stop contributing.
Taking the same example, if you decide to stop your contributions after 20 years, you will gain an 8% interest in the 21st year. This gives you an interest amount of $4,800. On the 22nd year and moving forward, you will still get the 8% interest. Also, take note that your maximum Roth IRA contributions depend on your status for tax filing as well as your modified adjusted gross income.
Withdrawal of Your Roth IRA
Interest on some assets within a Roth IRA make Roth IRA accounts an enticing investment choice. You may even use it as an alternative to paying fixed-rate mortgages or adjustable rate mortgages. Understanding how interest functions within the savings account are important. However, you must also understand how to make withdrawals and withdraw your funds when your retirement time comes.
Generally, you have the freedom to withdraw your tax-deductible contributions anytime. Keep in mind though that you must withdraw your contributions that are tax deductible first before your earnings in your Roth IRA. In contrast to your contributions, you can only withdraw the earnings if you are at least 59 1/2-years-old. Additionally, your account must be at least 5 years old. This is if you do not want to make an early withdrawal of your tax-free income.
Investing in a Roth IRA while you are still young is better if you want a longer contribution period. Besides, the older your retirement account gets, the higher your Roth IRA interest rates will become. You may also calculate the annual percentage yield to measure the effectivity of the return rates of your investments. Ultimately, this means bigger returns from your savings plan when you retire.
When are you going to invest in Roth IRA? Let us know in the comments section below!
Editor’s Note: This post was originally published in November 2017 and has been updated for quality and relevancy.