Peter Thiel, a PayPal co-founder, invested approximately $2,000 worth of PayPal shares in a Roth IRA during the late 1990’s. Today, those shares are worth an estimated $5 billion, and Thiel won’t owe taxes on any of the gain if he waits until the age of 59 ½ to withdraw money from that account. Although it’s unlikely that Thiel’s success can be replicated by an ordinary investor, his story demonstrates that Roth IRAs are a great place to hold those investments carrying a high-risk, high-return label.
What is a Roth IRA and How Can You Create One?
A Roth IRA is a retirement account that is funded with after-tax dollars. The benefit and most important fact about Roth accounts is that money invested in the account grows tax-free. This means you won’t owe taxes on the money earned when investments in the account appreciate in value. The decades of tax-free growth that a Roth IRA offers often makes it the last account that retirees pull money from.
There are some limitations to Roth accounts, however, including caps on annual contributions and personal income. In 2022, annual contributions to a Roth are limited to $6,000 for people under 50, and $7,000 for people 50 or over. To make those maximum annual contributions each year, single people can earn no more than $125,000 per year, while married couples can’t earn more than $198,000 jointly. Unfortunately, those exceeding the specified income thresholds are not eligible to contribute to a Roth account.
A popular way to establish a Roth IRA is through a rollover. If you have already contributed to a Roth 401(k) or 403(b) through a former employer’s plan, you can transfer the balance of the account directly to a Roth IRA. Otherwise, after-tax amounts that have been stashed in a non-retirement account such as a checking or savings account can be used to fund a Roth IRA.
Determining if a Roth IRA is Right for You
The potential of reducing tax liability shouldn’t be the only factor that determines what portion of your savings to allocate to higher-risk investments. Instead, the share allocated in “risky” investment strategies should be determined by an individual’s tolerance for risk, investment goals and age.
Considering a Roth IRA as part of your financial plan or retirement savings? Don’t go it alone! A financial advisor can help determine if it’s appropriate for your personal investment strategy.