Why max out Roth IRA?

While it might make sense to max out Roth IRA contributions, this may not be the right move for everyone. Here is why you should max out your Roth IRA.

3 min read

When it comes to saving for retirement, you should contribute as much as you can to maximize your retirement goals. If you have a Roth IRA, you contribute post-tax dollars to your retirement account, and the money will grow tax-free over your working years. To get the full tax benefits of a Roth IRA, you should focus on maxing out your contributions.

When you max out your Roth IRA contributions, your retirement savings benefit from long-term tax-free growth until when you start taking distributions from the account. Also, since you pay taxes upfront, a Roth IRA eliminates the probability of paying higher taxes since you won't pay tax or penalties on qualified Roth IRA distributions.

Should you max out your Roth IRA?

Although a Roth IRA will not give you an immediate tax break on your contributions, the money you contribute to a Roth IRA will grow tax-free and you won’t owe any taxes when you take qualified distributions from the account.

If you expect to pay higher taxes when you retire, it makes sense to max out your Roth IRA contributions. This might apply if you are at an early stage in your career, and you expect to climb up the career ladder. As you move up the job ranks and earn more money, you get to keep more money than if you contributed pretax dollars to your retirement account.

Additionally, a Roth IRA gives you access to a wider pool of investment options than you will find in a 401(k) or other employer-sponsored plans. Examples of investment options available in a Roth IRA include ETFs, mutual funds, stocks, and certificates of deposit.

Roth IRA contribution limits

If you have an earned income and you meet the eligibility requirements for Roth IRA, you can contribute up to $6,000 to a Roth IRA in 2022. If you are above age 50, you can contribute an extra $1,000 to a Roth IRA, bringing the total contributions to $7,000. If you have both Roth IRA and traditional IRA, your cumulative contributions should not exceed $6,000, or $7,000 if you are above age 50.

The IRS provides certain income limits that determine if you are eligible to contribute to the account. If your income exceeds certain thresholds, the amount you can contribute to the account starts phasing out. However, if your gross income exceeds the income limits, you won’t be eligible to contribute to the Roth IRA.

Why you should max out Roth IRA

Benefit heirs

If you have built a sizable nest egg, you may not need to spend all the retirement money during your lifetime. Once you die, the remaining Roth IRA assets will be passed on to your named beneficiaries who can include your children, grandchildren, parents, or even sisters/brothers.

Once your beneficiaries inherit the Roth IRA, they won't be required to pay taxes on any withdrawals taken from the account. However, they must take the full distribution from the Roth IRA within 10 years.

Some beneficiaries like children below 18 years may be exempted from the 10-year rule. In this case, the rule will only kick in once they reach the age of majority.

Tax rates can change

Tax rates are subject to change at any time, and you can use a Roth IRA to protect yourself from tax increases. Since you will pay taxes when you contribute to the account, you lock in a lower tax rate so that you won’t owe further taxes on Roth IRA withdrawals.

Long-term growth opportunity

When you max out your Roth IRA contributions, you allow your money to grow in the long-term without having to worry about stock market volatility and inflation. The money you contribute to your Roth IRA is invested in various investment options like ETFs, bonds, stocks, and mutual funds, which helps diversify your earnings. Your money will grow tax-free through compounding, and your contributions and earnings could grow into a sizeable nest egg.

Backup your emergency fund

Since you contribute post-tax dollars to a Roth IRA, it means that taxes have already been taken out from your contributions. Therefore, you can tap into your Roth IRA account at any time without owing any taxes or penalties.

If you have a financial emergency and you have exhausted your emergency fund, you can use your Roth IRA money as a backup emergency fund. You can tap into your Roth IRA contributions tax and penalty-free to act as a buffer against serious emergencies. However, you should only withdraw from your Roth IRA as a last resort, since early withdrawals could erode your retirement money.

Where to invest after maxing out Roth IRA

If you have maxed out your Roth IRA contributions, you have several options for investing your money:

Max out your 401(k)

If you have a 401(k) with your employer, and you contribute enough to collect a 401(k) match, you should consider topping up your contributions. In 2022, you can contribute up to $20,500 to a 401(k), and an additional $6,500 in catch-up contributions if you are above 50. Maxing out your Roth IRA and 401(k) can help you build a sufficient pool of retirement assets that you can live off in retirement.

Contribute to the employer’s Roth 401(k)

If your employer offers a Roth 401(k), you should check if you are eligible to join. Contributing to a Roth 401(k) gives you the same advantage as a Roth IRA, except that you get access to a small pool of pre-selected investment options. If your employer offers a 401(k) match, you will receive the match, but the funds will be added to a pretax 401(k) account.