All about Roth IRA: step by step instructions on opening an account and setting it up
A lot of you have questions about Roth and have been asking me to create a more beginner friendly step by step instructions so here it is...
Why Roth and not traditional pre-tax IRA?
that's the subject for the next blog.
To know more about why you even need a Roth, read my previous article on Roth IRA here.
You can open a Roth IRA account with brokerage firms such as Fidelity, Vanguard, or Schwab. There's many others, but these are the big three. For simplicity's sake we will only talk about Fidelity.com
Go to Fidelity.com and click on "open an account"
Then select retirement and IRAs.
Then pick open a Roth IRA.
You will go through a few questions to set up your new account.
Most importantly you need to have earned income in order to be allowed to contribute in the first place.
You may or may not qualify for a regular Roth IRA contribution depending on your modified adjusted gross income (MAGI) per the IRS.
Go to IRS.gov to check because the qualification numbers change every year.
However anybody can open a Roth IRA account. You may not qualify to contribute to a regular Roth but you may qualify for a backdoor or mega backdoor Roth, which I also wrote an article on previously.
All of these info can be found in the IRS.gov website. I understand they aren't always easy to decipher, that's why I write these blogs.
As a reminder, this is a personal blog. All information you see here, I gathered through my own research, but I am not a certified financial advisor. I'm just sharing what I've learned and have done to build wealth and to do it effectively. But you must always do your own research and seek advice from qualified professionals. This just opens up the idea for you to start and even know about this at all.
You don't know what you don't know and you can't ask questions when you have no idea what questions to ask.
Back to the article...
If you qualify for regular Roth IRA contributions then you can fund your now established Roth account with cash from your bank account. Contribution Limits change per year so you must check the IRS website to make sure.
If you don't qualify for a regular Roth IRA, because you make too much money per the IRS, you can most likely qualify for a mega backdoor Roth contribution.
That is if your employer gives you that option.
That's right, not all employers allow this, so check with your retirement representative first.
What is a mega backdoor Roth:
- your contribution doesn't come from your bank account.
- your contribution is coming from your paycheck.
- you set up after tax contributions to a 401k, 403b, or 457b account, whichever is available through your employer.
- It's mega backdoor because you are now allowed to contribute 3x more than the allowed contribution on a regular Roth IRA. Because contributions to a 401k, 403b, or 457b is about 3x more see the limits here.
How to set that up?
On your workplace retirement website you can select to start contributing after tax dollars to a retirement account. It could be a 401k, 403b, or 457b. Pick one to start. And select to contribute after tax dollars from your pay check.
You can always call your retirement representative and they will walk you through it. That's what they're paid to do.
At this point, you should already have opened a personal Roth IRA account as I have stated above. Because that's where the money eventually gets transfered into.
Once the money is on the 401k account, keep it in cash, to keep things simple. Otherwise, you will have differing tax implications on what you have contributed and the earnings it generates while the money is still in the 401k, 403b, or 457b.
Call your workplace retirement representative and tell them you want to transfer these after tax dollars (you tell them the amount you want) on your 401k into your personal Roth IRA account.
After a few business days, the transfer should clear.
When you see the money in your personal Roth IRA account then you can now pick investments and start to invest your money under your own Roth IRA account. Now any earnings generated while it's in your personal Roth can grow tax free (just remember the 5 year rule caveat of Roth IRAs).
What to invest in
It really depends on your risk tolerance.
But a general rule of thumb is to pick funds or ETFs that is very low cost.
You can screen these choices under the research tab in fidelity's website after you've logged in.
All brokerage firms have research tabs, to help you find which investments work best for you.
Also you can call their representatives to help you.
Passive index funds or ETFs are usually low cost and a pretty stable bet most of the time.
Examples are:
FXAIX for fidelity. It tracks the S&P 500. If you search for FXAIX you will see that the expense ratio is only 0.015%. That is how much you pay per year to own that fund.
I also like to see low turnover rates, because that eats into your profits.
FSKAX tracks the Total US Market, if you want a broader coverage.
Fidelity doesn't have exchange trades funds (ETF) versions of these, unlike Vanguard. But it doesn't really matter because you are buying these funds in fidelity.
If you have a Vanguard Roth IRA account and bought these funds in Vanguard you would have to pay a transaction fee of $100 because fidelity owns this fund, not Vanguard.
That's all for now to get you started. And if you have questions leave them in the comments section below so that other readers can benefit from it.
Let's help each other out.
All questions are great questions because that's how we learn.
See you on the next one!
-Pam
As a reminder, I created this blog to share information and to increase everyone's financial literacy. This serves as my notebook that I willingly share publicly to help others increase their curiosity and knowledge in wealth building and money management. I am not an official financial advisor, lawyer, or accountant. You will not find legal advice in this blog. Read the full terms and conditions here.
