Reaching the million-dollar mark for retirement savings feels like a triumph for most retirement savers. The only thing that might make reaching the milestone even more rewarding is if that money was accessible without any tax liability.
Well, that's a possibility. Unlike traditional IRA accounts (sometimes called contributory IRAs) funded with pre-tax contributions and taxed as money is withdrawn, distributions from Roth IRAs are tax-free. You simply forego any tax-deduction benefit when putting money into them.
An elite group of investors has taken masterful advantage of these differences -- along with the tax rules regarding them -- to become Roth IRA millionaires. And not workplace Roth 401(k) accounts either, where larger contribution limits make it far more likely to reach the seven-figure mark. We're talking about ordinary Roth IRAs with the same yearly contribution caps that apply to traditional IRAs.
Here's what you need to know about how they achieved the seemingly impossible.
1. The bulk of the money likely started out in a non-Roth IRA
First and foremost, know that the vast majority of investors with million-dollar Roth IRAs probably didn't grow this enormous nest egg within this particular account.
Since their creation in 1998, the most money anyone currently under the age of 50 could have possibly deposited into their Roth is a little less than $125,000. For older investors who have taken advantage of so-called "catch-up" contribution caps, the ceiling would still only be $145,500. Both are nice chunks of change, but even when invested during what overall has been a pretty strong period for the stock market over the past 27 years, it still leaves most investors short of the $1 million mark.
Another way people have built up Roth IRA wealth was to convert traditional IRAs (which have been around a lot longer) or work-sponsored retirement accounts into Roth IRA accounts, opting to pay the hefty subsequent tax bill out-of-pocket at the time the conversion was made.
This move works great if your chief goal is sidestepping future income taxes and required minimum distributions of this money. To work well, however, you'll want to make a point of putting all of this money into a Roth rather than using some of the converted assets to cover the tax bill created by a Roth conversion. This, of course, assumes you have access to enough extra cash to do so.
Pro tip: You're not required to convert the entirety of an ordinary IRA into a Roth in one shot, thus potentially pushing more of your taxable income into a higher tax bracket. You can stagger these conversions as a means of better controlling the tax consequence.
2. The others invested (very) well and/or maybe got a little lucky
That being said, not every single ordinary Roth millionaire got there by converting a traditional IRA or 401(k) to a Roth account either. It's possible they reached their seven-figure goal by being very, very good stock pickers.
As was noted, even investors who've been able to take full advantage of every catch-up contribution since they were first introduced in 2002 would still have chipped in less than $150,000 to their Roth during their entire lifetime. And most of that would have happened in the latter half of the past 27 years since Roth IRAs were first unveiled (meaning time and compounding didn't work to their full advantage).
Assuming the market's average annual rate of return of around 10% was seen on this money, that would still leave you in the ballpark of only around $550,000.
So, how'd a handful of investors manage it? As was suggested, they were just really, really good at picking stocks...or perhaps they were just lucky enough to be in the right place at the right time and willing to take the right shot in the dark.
Ever heard of Peter Thiel? He's a tech entrepreneur now but was also a co-founder of what we today call PayPal, buying a sub-$2,000 stake in the start-up company in his Roth IRA back in 1999. His piece of the then-unknown fintech name has since grown tax-free to a value of around $5 billion. It's going to come out tax-free, too, as and when Thiel decides to withdraw it.
This is obviously an exception to the norm; most of us don't have the opportunity to launch and then buy a piece of our own publicly traded companies that end up becoming multibillion-dollar enterprises. You get the idea, though. There's a case to be made for using your Roth IRA to hold high-payoff prospects.
3. They're thinking strategically (and realistically) about income taxes
Finally, while the premise of a Roth IRA has its obvious appeal -- tax-free growth and then tax-free withdrawals -- that doesn't inherently mean they're the best option for all investors. A traditional IRA funded by tax-deductible contributions may be a smarter choice for you if your future income tax liability is apt to be lower than your current one.
Figuring this out will, of course, require some projection as to what the future holds, which can be tricky. Tax brackets and tax rates change. Future income is also tough to predict since it's largely a function of how much growth your retirement account achieves in the meantime.
Still, most people with million-dollar Roth IRAs have crunched the numbers as plausibly as they can and have a specific reason for funding this sort of tax-sheltered account rather than a traditional IRA. You would be wise to do the same for yourself.
It's possible but not probable with just a Roth IRA
Ready to give it a shot? Great. Just don't lose perspective on what's possible versus what's probable.
See, even if you've maxed out your contributions to a Roth IRA and invested this money well, it's still unlikely older investors will reach the million-dollar mark. There's just not enough time and opportunity to tuck enough money away in these vehicles to get there in the foreseeable future. Only younger investors are in a position to become ordinary Roth IRA millionaires.
The thing is, that's OK. You also likely have access to a workplace 401(k) plan with much larger contribution limits. Some of these plans even allow for after-tax contributions and don't tax any withdrawals from these accounts later in life. When combined with all your combined investment options, it's still very possible for average people to become millionaire retirees.
The key -- as always -- is to get started as early as possible and stay the course to achieve market-average returns.
