Starting a Roth IRA with $12,000

As of the start of 2020, my goal has been to make progress towards getting out of debt, building wealth, and reaching financial freedom. All three of these objectives will take quite a while, but I feel that now is one of the best times to get started on a wealth building journey in the stock market. I am starting on my journey by trying to utilize all of the tax advantaged accounts that are available to me, which includes a Roth IRA.

In this article, I talk about how I started a Roth IRA, what brokerage I am using, why I chose to fund it with $12,000 instead of $6,000, and what I chose to invest in during this time of uncertainty in the stock market.

Let’s get started.


Roth IRA

A Roth IRA is different from a traditional IRA in one major way, tax treatment. With a Roth IRA, you pay taxes on the money that you contribute today so that all of the gains that you receive on your investments in the future can be withdrawn tax-free. This differs from a Traditional IRA, because with a Roth IRA, you will not be able to deduct any contributions on your tax statements.

If you want to read more about exactly what a Roth IRA is, read this article that I wrote previously: Roth IRA vs Traditional IRA: What’s the Difference?


How I started my Roth IRA

I started my Roth IRA by using Charles Schwab as my brokerage company. The reason why I chose Charles Schwab is because they have great index funds with low expense ratios compared to competitors. Also, the recent move to offering commission free trading on all securities was a big deal in convincing me to switch over.

I started my Roth IRA by simply opening my Charles Schwab account, going into the settings tab, and clicking “Open a Roth IRA”. From that point on it was pretty straightforward by not having to enter much information as they had drawn a lot of my personal information already via the account.

Once I had checked all of the boxes stated that I understood the limitations that a Roth IRA had compared to a regular brokerage account, I was then able to immediately begin funding my account. The only critique I would have about this process of opening a Roth is that Charles Schwab doesn’t allow you to immediately invest the money that you choose to deposit. You have to actually wait until the money gets into your account, which could take 2-3 business days, and that may cause you to miss out on a good opportunity to buy in to the market.


Why I Chose $12,000

The reason that I decided to fund my Roth IRA with $12,000 is because of the annual contribution limits that the government imposes on tax advantaged accounts. Typically, you are only allowed to contribute a maximum of $6,000 of after-tax income to your Roth IRA. However, since I was starting my account, I was able to take advantage of 2019 contributions as well as the 2020 contribution. I also had to option to go ahead and contribute for 2021, but I elected to wait for those contributions.

This is a big deal. This is a big deal to me because it gives me a lot more capital to grow and compound in this tax advantaged account, and in this account all of the gains can be collected tax free once I reach the age of 59 ½. While this may be a long way away as I am only 21 years old right now, the more money that I am able to shelter from taxes later in life will be a large benefit to me.

If my end goal is to reach financial independence as soon as possible than it is vital to take advantage of as many tax breaks that you can get because it allows you to keep more money in your pocket and away from the prying hands of the federal government.


What Did I Buy with $12,000

My strategy for my Roth IRA will be to invest in market based index funds that I can follow the entire stock market. For the $12,000 that I deposited, I elected to buy Charles Schwab S&P 500 Mutual Fund SWPPX. SWPPX is a low cost index fund that has an objective of trying to track the S&P 500 as close as possible. The expense ratio for this mutual fund is only 0.02% which is very competitive to many of the other mutual funds on the market.

If you want to learn more about exactly what SWPPX is read my article here:

Schwab S&P 500 Index Fund (SWPPX): What is it exactly?

This is one of the more “boring” ways to invest in the stock market because you can go around any corner and you will hear a financial advisor trying to find ways of “beating” the S&P 500 instead of trying to keep up with it. The history states that it is very uncommon to beat the S&P consistently, which is why I would want my money in a much more consistent security than in speculative investments.


Now let’s go into some pros and cons that I have encountered so far.

Pros

  • Able to build tax-free wealth for the future. If my income bracket is higher in the future, this will be an excellent way to hedge against the higher taxes.
  • Easy to start and manage
  • Flexible with the variety of investments that I can choose to make

Cons

  • I won’t be able to access this tax-free money until I turn 59 ½, which is long after I plan to retire originally.
  • There is a withdrawal fee of up to 10% if I have to access these funds earlier than expected
  • For SWPPX specifically, you have to wait until the end of the market day before your order is filled. Because it is an index funds, it is not as liquid as an ETF or stock.

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DISCLAIMER:

As I am not a Certified Financial Adviser, any information that you read here is purely for educational and entertainment uses only. For professional legal advice, contact a CFA.

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