A Roth IRA is a smart way to grow your savings for the future. These investment accounts offer tax-free income when you retire. Of course, any return you see on a Roth IRA account depends on the investments you put into it. Here’s what you need to know about the average Roth IRA return and how it can help you maximize your retirement savings.
How a Roth IRA Works
Before we dive into Roth IRA returns, it’s important to understand what this type of IRA is and who can open one.
A Roth IRA is an individual retirement account that you contribute to using after-tax dollars. This setup allows the account holder to take tax-free withdrawals once they have had the account for five years and are over the age of 59½. In this way, Roth IRAs are the inverse of tax-deferred traditional IRAs or 401(k)s; with those accounts, you’ll have to pay taxes when you withdraw the funds.
The 2020 contribution limits for Roth IRAs are unchanged from 2019 — you’re allowed to contribute up to $6,000 per year (or $7,000 if you’re over 50). But there are income limits for Roth IRAs. To open one in 2020, for example, you cannot earn more than $124,000 if you’re single. For married couples filing jointly, the limit jumps to $196,000 for 2020. Make sure you meet the eligibility requirements before opening a Roth IRA.
How a Roth IRA Earns Interest
Unlike traditional savings accounts, Roth IRAs don’t earn interest on the account alone. Essentially, a Roth IRA account starts out as an empty investment basket — meaning you won’t earn any interest until you choose investments to house within the account itself.
Roth IRAs earn interest by compounding, which helps your money grow more quickly. Whenever your investments earn a dividend or interest, that amount gets tacked to your account balance. Then you earn interest on that interest, and so on. That means your money will continue to grow even if you don’t make regular contributions to the account.
There are several factors that will impact how your money grows in a Roth IRA, including how diversified your portfolio is, your timeline for retiring, and your risk tolerance. That said, Roth IRA accounts have historically delivered between 7% and 10% average annual returns.
Let’s say you open a Roth IRA and contribute the maximum amount each year. If the contribution limit remains $6,000 per year for those under 50, you’d amass $83,095 (assuming a 7% interest rate) after 10 years. After 30 years, you would accumulate over $500,000.
On the other hand, if you decided to put your money in a savings account that didn’t yield interest, you would only have $60,000 after 10 years ($6,000 multiplied by 10). To calculate the growth of your contributions, check out SmartAsset’s free investment calculator.
How to Maximize Your Roth IRA Returns
Just because a Roth IRA helps you save for retirement doesn’t mean that all accounts are created equally. Where you choose to open an account can have a big impact on the investments you can select, thus impacting your return. For example, a traditional bank may only offer Roth IRAs as a certificate of deposit, which typically has a lower rate of return.
For the widest variety of investment options, it may be best to open an IRA through a broker. With a broker, you can select your investments based on both your financial objectives and risk tolerance. These investments could include a mix of stocks, bonds, index funds and exchange-traded funds (ETFs).
If you prefer a more hands-off approach, consider opening a Roth IRA account with a robo-advisor, which uses software to manage your investments online. These types of accounts usually come with lower fees as well, since no human advisors interact with your portfolio — it’s all automated by computer algorithms that continually adjust for your age, timeline and risk tolerance. Many robo-advisors will use index funds or EFTs for your investment mix in your Roth account.
The Bottom Line
Roth IRAs are a popular retirement account choice for a reason: They’re easy to open with an online broker and historically deliver between 7% and 10% in average annual returns. Roth IRAs harness the advantages of compounding, which means even small contributions can grow significantly over time. That’s why is important to open a Roth IRA sooner rather than later — you’ll be better set for retirement the longer your money has to grow.
Tips for Investing for Retirment
Avoid becoming one of the Americans who hasn’t saved enough for retirement by making wise choices now. Researching Roth IRAs to find a suitable investment option for your needs is a step in the right direction.
When deciding where to open your Roth IRA, review the fees that each institution may charge. This will help maximize your savings.
Consider working with a financial advisor to help you meet your goals for retirement. Finding one who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
Photo credit: ©iStock.com/jxfzsy, ©iStock.com/Kameleon007, ©iStock.com/skynesher