Maxing out Roth IRA is the most overlooked advantage in the personal finance space. The maximum amount you can max out your Roth IRA for is $6,000 in 2022 ($7,000 if age 50 or older). Roth IRAs has tax advantages and gives you access to investment options you don’t get with a 401(k).
My biggest mistake in my personal finance journey was NOT maxing out my Roth IRA. By the time I graduated college, I had about ~$30,000 in cash in my savings account. Imagine if all of that $30,000 was sitting in a tax advantaged account such as the Roth IRA.
I would be swimming in tax free gains by now. Gains that I wouldn’t have to pay taxes on, as long as I reach the retirement age where there are no penalties. It took another five years before I decide to max out my Roth IRA. That’s right. I barely maxed out my Roth IRA for the 2021 tax year.
$6,000 that I plopped right into the account. There’s really no mathematical difference between keeping $6,000 in a savings account versus $6,000 in a Roth IRA. Why is that? You can withdraw the Roth IRA contributions (not earnings) at any point without paying penalties or taxes.
Except that the $6,000 in a Roth IRA has tax benefits. A regular savings account does not. Therefore, if it’s the same thing with one difference making the Roth superior to a regular savings account, why wouldn’t you be maxing out your Roth IRA? It’s a no-brainer decision.
I just wish that I took advantage of it sooner. I wanted the cash in my savings account for “liquidity purposes” which is not a valid argument in the personal finance journey.
Why You Should be Maxing Out Your Roth IRA
One reason why you should be maxing out your Roth IRA is because you can SMASH that social share button and post to your favorite social media! Your friends could use the article to better their life and if anything, do it for me.
So with that said let’s get into the reasons why a Roth IRA is awesome!
1) Tax Diversification
With a Roth IRA, you use taxed money to fund your account. Which means you are contributing money when you are theoretically at a lower tax bracket. Contrast this with the future in which you theoretically should be earning more money and at a higher tax bracket. This is the opposite from how 401(k)’s work.
With a 401(k) you are using pre-tax money today and delaying the tax event into the future. When you contribute to both the Roth IRA and a 401(k), you are diversifying your tax risk by having both kinds of tax events. Now, if your tax rates remain the same, there is absolutely zero difference between the two accounts.
However, that will most likely not happen with changes in administration, your income, and lifestyle. Maxing out your Roth IRA AND a 401(k) is a great way to diversify that tax risk. Because the future is so uncertain and there’s no way to know how it’ll unfold, it’s not a bad idea to prepare for taxes, no matter how uninteresting it is today.
2) Tax Benefits
Did you know Peter Thiel has five BILLION dollars in his Roth IRA, alone? If he just waits until 2027 he can withdraw all of that money, tax free. No questions asked. Just like that. Who knows what it’ll grow into by then? We can either complain that the system is rigged and stacked against us (it certainly is).
Or we can use that information for us. Now, 99.999% of us won’t be able to turn $6,000 maximum contribution for 2022 into five billion dollars. However, we can use this information to better our life. The gains you have in your Roth IRA is not taxed year over year nor is it taxed ever if you withdraw at a certain age.
We already pay our hard earned dollars to the government just for them to misuse our funds. Why not take advantage of every tax benefits the government gives us while it’s still available? Imagine for every dollar you make in investment gains, you literally keep 100% of them. How great would that be?!
Maxing out your Roth IRA makes that possible.
3) Ability to Take Out Money
Unlike the 401(k) which triggers penalty and tax events if any dollars is withdrawn before the allowed age date, Roth IRAs does not. As long as you’re only withdrawing your contributions and not your earnings or gains. That’s why it’s literally called “Individual Retirement Account” (IRA).
There’s essentially no difference in the usability of your money in a Roth IRA versus a bank savings account. That’s why maxing out your Roth IRA makes sense. If there’s no difference in the usability but there is difference in the tax benefits between one account over another, then it just makes sense to take advantage of the benefits.
This is what I didn’t understand or get when I hesitated maxing out my Roth IRA. I placed too high of a value on the liquidity and the usability of my money when it was in a bank account. Where it earned only like 0.3% interest rate. I could’ve easily taken out the money if I needed to, and for that is a big mistake that I can’t reverse.
How to Max Out Your Roth IRA
So now that you’re fully convinced maxing out your Roth IRA is the way to go, let’s go over into the specifics and the how to do so.
1) Open an Account
The first step in maxing out your Roth IRA is to open an account. Fidelity has a simple one click button page (not an affiliate link) in which you can open an account with. Afterwards, you can choose to manage your own investments, log-in or create an account, and then answer the subsequent questions.
It’s not as complicated as you may think. One of the reasons that was holding me back from opening an account is because I thought it was complicated. It’s not. You just have to click a few buttons and answer a few questions. It’s even easier if you already have an account with Fidelity.
You don’t even have to fund any money after you open an account. There’s no need. You can easily just let the account sit for months, as I have, until you feel ready and/or willing to contribute money into the account. Once you take care of the first step, then actually contributing money to it will be that much easier.
2) Save Your Money
Next is to come up with the $6,000 contribution limit. You don’t have to max it out in one go, you can contribute $500/month or even just $100/month if you have to. Either way, the next step is to actually save your money in order to max out your Roth IRA. There’s many ways to do so.
You can decide to eat out less, make food at home, and/or not buy the latest Nicholas Cage pillow for your couch. It’s time to exhibit good money habits. Every little bit helps because it compounds over time, little by little. There’s always a way to trim the fat and get to a good financial spot.
One wacky way I would save money is to bring my phone charger to the office so that I use their electricity instead of mine. One of my friends parks his Tesla car in the company garage, which allows free electricity charging. However way you can save money, it all adds up to significant amounts by the end.
3) Transfer the Savings to the Roth IRA
Now that you came up with savings, now it’s time to actually transfer the savings to the account! Preferably, it would be maxing out your Roth IRA. 2021 was the first financial year that I actually maxed out the Roth IRA. I have never done that before and I’m so glad that I did. Yes, it’s currently sitting in a money market account.
However, I can’t wait to start investing with it and see what it can produce. I just know that it’s going to add up to significant amounts over decades. The process is especially simple. All you have to do is link your current bank account information with the Roth IRA and then it’s just a matter of transferring the money.
This is the final step to maxing out your Roth IRA.
4) Invest the Money
This is the step many people fail. Too many people think Roth IRAs are an investment vehicle already just by contributing money to it. They just transfer the money to the account and let it to. That’s not right! You have to actually do something with the money and invest it.
Although maxing out your Roth IRA stops after you transfer the money into the account, the bonus step is to actually use the money. The advantages of a Roth IRA versus a 401(k) is the ability to invest in many options in the account. 401k investments are extremely limited by what your company offers.
Roth IRAs have much fewer restrictions. You can invest in many equities options through the account. I’m currently eying the S&P 500 index or the NASDAQ. The S&P 500 has made my portfolio so much money over the years and I fully expect it to continue making me money. The long term is what matters to me.
My Biggest Mistake is Not Maxing Out My Roth IRA
I estimate that I lost out on ~$30,000 worth of tax free gains by not maxing out my Roth IRA. I can’t imagine what I would do with an additional $30,000 sitting around in my bank account. It’s a pretty hefty sum for someone like me where that is more than my entire spending for the year 2021.
I spent close to $22,000 in 2021. Learn from my mistake. $6,000 per year doesn’t sound like a lot of money for an investment. It won’t make a dent in your life because even a 20% return on that is only $1,200. However, it’s not about what happens in one year. It’s about what happens over decades that matters.
I missed out on ~9 years worth of contributions to a Roth IRA. That’s easily ~$45,000 worth of contributions I could’ve made over the years, not even including the gains over the past nine years. I like to think that I did everything right about personal finance by maxing out my 401k and HSA.
However, this is a dagger mistake that really set me back. The worst part is that i don’t even realize that it’s set me back because to me, it’s theoretical money that I missed out on! Ignorance is bliss, as they say. It’s one thing to not take advantage of something because you didn’t know about it.
It’s another thing to not take advantage of something even after knowing about it. I want you to learn from my mistakes because I was the guinea pig who went through it all. Maxing out your Roth IRA one of the most overlooked actions in personal finance today because the vast majority talk about how great the 401k is instead.
Maxing Out Your Roth IRA is the Way to Go
I hope by now I convinced you that maxing out your Roth IRA is the way to go. One additional benefit to the Roth IRA is that you can actually use $10,000 of your Roth IRA money to pay for a downpayment for a house. Provided you haven’t owned a home in the past two years. This is a one-time benefit that not money know about.
You can withdraw this money penalty free, on top of that. Using penalty free, tax-advantaged money to get yourself a house? That shows that it’s an even better benefit than before! It’s best to take advantage of the account while you can and have an income under the income limit.
Congress is actually even thinking of taking out the Backdoor Roth options for high income earners. Therefore, all these wonderful benefits might be extremely limited and/or inaccessible as you get later in your career. You might not even be able to take advantage of the account so the sooner you do, the better.
I learned my lesson. Going forward, I fully plan and expect to max out my Roth IRA without fail and continue to max out my 401k and HSA as well. The yearly contributions won’t make a dent in my overall net worth and financial independence journey… Until it does.
It’s time to create your fortress of personal finance by maxing out your Roth IRA, 401k, and HSA. If you do that, there’s a chance that you can reach an even better net worth at a younger age than me. Allow me to make these mistakes so that you don’t repeat my mistakes in your life.
