A Roth IRA is an individual retirement account that allows you to make after-tax contributions to an investment account, eliminate taxes on money inside of the account and then make tax-free withdrawals from the account after age 59 1/2 as long as you've held the account for at least five years. But you should also concern yourself with getting a good rate of return on money in your Roth investments.
Roth IRAs may invest in bank CDs. These CDs are sometimes called Roth IRA CDs. A bank CD is a time deposit that is issued by a bank. You give money to a bank, and they guarantee you a rate of return for a specified number of years. A good rate on a Roth CD will be a rate that reflects the bank's best or highest paying rate for their investment portfolio. These rates are often given to individuals who invest a minimum amount with the bank, which is determined by the issuing bank. Additionally, the money may need to be kept with the bank for a minimum amount of time, often spanning several years. CD rates are generally fixed rates that mirror current bond interest rates in the marketplace. Thus, long-term CDs naturally reflect higher interest rates while shorter-term CDs reflect lower investment returns.
Roth IRAs may invest in an annuity. These IRAs are normally purchased through an insurance company, but banks may also contract with an insurer to offer a Roth annuity. Annuities are insurance policies. A deferred annuity acts as a long-term savings policy. The money in the annuity may be guaranteed against loss if it is a fixed annuity. However, variable annuities may also offer a guaranteed rate. Variable annuities are not technically guaranteed, since they invest in mutual funds which do not guarantee a specific rate of return. However, the insurance company may offer a guaranteed minimum accumulation benefit. This benefit allows you to take advantage of the insurer's investment experience. The insurance company gives you the benefit of a guaranteed investment rate if you allow the insurer to manage the investment allocation of the account and do not make withdrawals from the annuity. These annuities represent a good return that may exceed fixed interest rates and give you stock market returns without the risk of losing money. The insurer bears all of the risk.
Roth IRAs may invest in mutual funds. These Roth accounts are normally purchased from an insurance company or a financial institution that sells equity-based investments and advisory services. Mutual funds represent a collection of stocks and sometimes bonds that share a common investment objective. Mutual fund returns are not guaranteed. However, you have the potential to achieve rates of return higher than a fixed annuity or bank CD. You may even do better than an annuity with a guaranteed minimum accumulation benefit. This largely depends on the fund manager's experience and ability. The best rates of return will be had by investing in mutual funds with underlying investments that you understand and that the fund manager has experience investing in.
Roth IRAs might offer you the highest rate of return due to the inherent nature of the account. At age 59 1/2, you are eligible for tax-free withdrawals provided that the account has been in existence for at least five years. This may give you higher net income than you otherwise would have if your tax rate is higher in retirement than when you were working. But, if tax rates are lower than the rates you pay during your working years, you will actually experience a lower rate of return after tax than you would have had had you used a traditional IRA.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- "Life Insurance"; Kenneth Black Jr., Harold D. Skipper Jr.; 1994
- IRS: Publication 590
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