Is A Roth IRA or HSA The Best Way To Become A Tax Free Millionaire?
Updated: Dec 17, 2021
Becoming A Millionaire In Retirement
A million dollars is a hell of a goal. It's not just the quantitative goal of hitting six figures, but it's what it represents. It's the status, it's the freedom. If it's self-made, maybe it's the satisfaction of a job well done, or maybe you're just getting started. Regardless, becoming a millionaire should theoretically be getting easier. With greater access to technology and more ways to earn money, younger generations should have more access to money making ventures. However, we are still in a savings crisis in this country. The average 401k balance of a 65+ year old American is $215,000, according to a study by Personal Capital. And while this sounds like a decent amount of money in the bank, Ally recommends that an individual should have around 7-9 times your income when you're in your 60's. When you do the back-of-the-napkin math on the average 401k, that means that average $215,000 balance is the result of an individual with a $30,000 per year job, which is highly unlikely given the average American household income is around $88,000. So what gives?
The American savings crisis can be boiled down to three main factors:
Not taking advantage of the financial assistance available to them
While debt and overspending are absolutely critical pieces of this puzzle, I'll be covering those more in-depth in a later article. For now, just know that millennials are screwed, and it ain't the avocado toast hitting those bank accounts the hardest. But I digress. What we're going to talk about today is the most powerful, most advantageous, most rigged account in the financial game. Today, we'll be talking about the Roth IRA.
What Is It?
A Roth IRA is as close to financial pornography as you'll find anywhere. Introduced in 1997 by Senator William Roth, this revolutionary retirement account allows an individual to contribute up to $6,000 per year (unless you're over 50 years old in which case you can contribute $7,000 per year) of post-tax money. That part is critical so read it again. "Post. Tax. Money."
Why is that so important? Because it's "pretaxed," which means you're absorbing taxes on the front-end. That means that when you turn 59 and one half years old, you can withdraw your money completely tax free. Nothing. Nada. Nothing the government can take from you. Did you max out your contributions every year and now your account is 100x what you put in? Congratulations! You won the game. That money is yours and yours alone and there is literally nothing that can be taken in taxes, potentially resulting in enormous gains. Now you see why I love this thing so much.
How Does It Work?
Opening a Roth IRA is as simple as opening a brokerage account. Log onto your preferred brokerage website if you have one (except Robinhood which currently doesn't offer retirement accounts), and click "Open an Account." From there, the brokerage will ask you a few questions so have your Social Security card ready! After that, connect a bank account and get contributing. However, it isn't all sunshine and rainbows. There are a few things you need to keep in mind:
You cannot contribute more than you earn. If you work a part time job and you're making minimum wage with a Roth IRA, first of all, contact me because I'd love to interview you. Second, you cannot contribute $1,000 if you've only made $500. You'll pay a penalty.
There are income limits. If you are an individual and make over $140,000 per year, you cannot contribute to a Roth IRA. Same goes for a joint tax-filing couple making over $208,000 per year.
The contribution limits I mentioned earlier are very strict. You cannot contribute more than $6,000 to the account in a single tax year if you are under the age of 50, or $7,000 if you're over the age of 50. If you contribute over this amount, you will incur a 6% penalty on everything else contributed, so probably don't do that. It's important to note on this one that dividends are not included in this calculation. If you have $100,000 in your Roth IRA and all of that pays a combined 3% dividend, theoretically your contributions could total $9,000 for that year ($6,000 contributions + $3,000 in dividends paid by existing holdings.)
You have to actually invest the money. Financial Tik Tok is rampant with people talking about opening a Roth IRA and contributing money, but not seeing that money grow because they didn't invest the actual money. Those people are called "idiots" and should contact their brokerage directly about how to get started.
Do I Have Other Options?
Absolutely! The Roth IRA is not meant to be used in a vacuum because $6,000 per year is likely not going to be enough to retire on later in life. It's meant to be used hand-in-hand with other retirement accounts to give you the best possible chance at success. So what are those other options? Here are the main three:
401k - This is the most popular form of retirement account. Available to employees, this is a company-opened account where employees can contribute up to $19,000 per year in pre-tax money. Employers will often match a certain employee contribution amount per year, essentially granting you "free money." Keep in mind that when you retire, this money will be taxed. 401k's also tend to have much fewer investment options available for your money, typically limited to index funds, mutual funds, bonds and occasionally company stock.
Traditional IRA - if you've already maxed out your 401k and are looking for another pre-tax retirement account option, you've found it! A Traditional IRA is essentially an extension of the 401k that blows past the contribution limits, if you can afford it.
Health Savings Account (HSA) - an HSA is a criminally underutilized investment vehicle, because those that have it typically don't know it can be used as an investment vehicle. This account exists to pay medical bills, but that's certainly not its only function. It's actually the most powerful retirement account around because it's "triple tax-advantaged." That means the money contributed to this account comes out of your paycheck pre-tax, grows tax free, and is tax free when you withdraw it in retirement. The downside? Again, it's meant for medical bills so it's likely you could spend through the account fairly quickly. The contribution limit for this account is also very low at only $3,500 per year.
Will This Be Around Forever?
Since this is a government-founded plan and would have profound implications on millions of Americans if this were to suddenly disappear overnight, it's incredibly unlikely that it goes away. However, Congress has recently been looking into changes to Roth IRA contribution rules due to the magnifying glass ProPublica applied to several wealthy peoples' Roth accounts, most notably the venture capitalist Peter Thiel. I wrote about this last month so please check out that article for a more in-depth look at the circumstances, but essentially Thiel deposited $2,000 in 1998 into a Roth IRA and purchased millions of shares of his company at the time, Paypal. For those more plugged-in to the finance world, Paypal has gone on to become one of the largest digital payment processors in the world, and that $2,000 investment is now worth somewhere around $5 billion.
This legal exploitation of the rules has spurred some members of Congress to take another look at the rules around Roth's. Representative Richard Neal (D-MA), Chairman of the House Ways and Means Committee, stated he's exploring instituting limits on how much money can be in a Roth IRA, which would effectively destroy the point of a retirement account. Senator Ron Wyden has been on this train for awhile, first proposing a Roth IRA limit of $5 million back in 2016, and seems to have gained support after the release of the Thiel story.
So Should I Open A Roth IRA?
First, let me say that this article is for educational and entertainment purposes only, and should not be viewed as investment advice. Now that I have that out of the way: hell yes you should open one of these, assuming you have the money to do so and fall within the contribution limit rules. Since you cannot withdraw this money until you retire (sort of), you should not invest any money you'll need in the near term. Make sure you have a fully stocked savings account, and take advantage of any 401k benefits your employer may offer to ensure you're fully, and legally, taking advantage of the tax code. After that, go nuts!
Do you have a Roth IRA? Are you planning on opening an account? And what do you think of the potential changes to a Roth IRA by Congress to close rich-people loopholes? Sound off in the comments below! And don't forget to sign up for my email list so you get these in your inbox as soon as they post. Thanks for reading!