What Does a Roth IRA Earn?
Opening a Roth IRA can be a effective way to save for retirement, but it is important to choose your investments wisely. The amount you earn on your Roth IRA depends on a number of factors, including the investment mix you choose and how well each of those investments performs in the years leading up to retirement.
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Types of Investments
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The return on your Roth IRA depends on the types of investments you put into the account and on how well those investments perform. The Roth IRA itself is merely the investment vehicle. You can use that investment vehicle to invest in a wide variety of securities, including individual stocks and bonds, mutual funds and bank instruments, such as certificates of deposit (CDs) and money market funds.
Risk vs. Return
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As with all investments, risk and reward are interrelated when it comes to your Roth IRA. You can keep all your Roth IRA money in conservative investments such as money market accounts and certificates of deposit at your local bank and know you will not lose money. But over time, you could lose purchasing power, because the low yields on those safe investments may not be enough to keep pace with inflation. It is important to consider your tolerance for risk and your own investment style when choosing a mixture of stocks, bonds, mutual funds and guaranteed investments.
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Retirement Proximity
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How close you are to retirement should be a factor in your retirement planning, including the choice of investments for your Roth IRA. If you are decades from retirement, you may want to keep most, or perhaps all, of your money in the stock market. You have time to recoup losses while realizing gains from the stocks' appreciation. But as you get closer to retirement age, it makes sense to move more of your money to safer investments, such as government bonds and bank CDs, so you are not subject to a sudden loss of funds.
Tax-Free Earnings
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No matter how you choose to invest your IRA funds, the money you make in the account is not subject to federal taxation as long as you do not withdraw your earnings before you reach age 59 1/2. Contributions made to a Roth IRA are made with after-tax funds, so contributions can be withdrawn anytime without being subject to income tax. However, the earnings on those contributions are subject to income taxes and a 10 percent penalty if they are withdrawn before age 59 1/2. Those earnings grow tax-free if they are not withdrawn until you are at least 59 1/2. This is different from a traditional IRA, in which funds are contributed on a tax-deductible basis but all withdrawals are subject to income tax. This tax-free status makes the Roth IRA an attractive vehicle for growth stock funds and similar investments.
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