How much will your Roth individual retirement account (Roth IRA) be worth in the future? The value of a Roth IRA is determined in large part by its rate of return. Over enough time, those returns can eventually exceed contributions, thanks to the power of compounding.
When you save for retirement in your Roth account, it's recommended that you work toward a specific investment goal rather than just maximizing your yearly contributions. Having a target in mind can ensure future financial health. Until you establish such a goal, there isno objective way to evaluatewheter you are saving enough.
Key Takeaways
- A Roth IRA is a tax-advantaged way to save for retirement.
- How much a Roth IRA will be worth is determined by its rate of return.
- In addition, thanks to the power of compounding, returns may eventually exceed contributions over time.
- Most experts suggest using 80% of your current income as a guide to help you plan your retirement savings.
- Factor into your plans your current age, the age when you plan to retire, and your life expectancy after you leave the workforce.
How Much Do I Need to Save?
If you have not yet determined an investment goal, below is a formula for estimating how much you’ll need in your nest egg to fund the retirement lifestyle that you want.
Step 1: Estimate the Income You Will Need in Retirement
This step is tricky because you are estimating expense levels for a life you are not yet living. Many financial planners recommend using 80% of your current income as a yardstick to simplify this calculation.
We’ll use a hypothetical figure and time frame for this article. In this case, let’s assume an income of $10,000 per month, which at 80% is $8,000, or $96,000 per year.
Step 2: Subtract Social Security and Pension Benefits
You can find this information in your Social Security Earnings Record, which is viewable on the agency’s website. You can also find this information through your company’s human resources department.
Subtract these benefits from your expected monthly retirement income in Step 1. If you have other sources of guaranteed income, such as monthly annuity payments, subtract those, too.
For our example, weassume that monthly Social Securityand pension income will be $4,000 per month. This reduces the income needed at retirement to $4,000 per month, or $48,000 per year.
Step 3: Factor in Time Horizons
There are three numbers you should be concerned with here:
- Your current age
- Your expected retirement age
- The number of years that you expect to live after you leave work or your investment horizon
You can use life expectancy charts to determine how long you can expect to live as a retiree, but it can be just as easy to consider the longevity of your close relatives and then round up.
For our example, we’ll assume a current age of 35, a retirement age of 65, and that you’ll live as a retiree for 20 years.
About one-third of American workers say they’re saving less than 5% of their salaries for retirement.
Step 4: Determine the Return on Your Retirement Assets
There is no way to precisely calculate the return on investment (ROI) for your savings, but the long-term ROI in the stock market is about 8%.
You can expect a lower rate of return on your retirement assets once you retire since, in all probability,your investments will be relatively conservative. For our example, we assume an ROI of 8% until retirement and 5% after that.
Step 5: Account for Inflation
It is a good idea to account for inflation, as it can have a major effect on the outcome of your plans. Remember, inflation is the rise in prices over time. Inflation erodes purchasing power, so the value of one dollar today won't be as much in the future. This means that a single dollar (or other unit of currency) will buy less tomorrow than it does today. For our example, we assume a 3% inflation rate.
Step 6: Put It All Together
Here’s what we have so far:
- Required yearly retirement income: $48,000
- Current age (35), retirement age (65), and years in retirement (20)
- Rate of return of 8% before retirement and 5% during retirement
- Annual expected inflation rate of 3%
You can usean online calculatorto do the math. Using the figures from our example, you will need to accumulate approximately $1.97 million to retire at age 65 with 80% of your current income.
Now you have a goal to aim for with your retirement investments: $1.97 million. When you make contributions, you will know how close you are to reaching your goal.
Saving for retirement can seem like a daunting task. You have to be incredibly disciplined with your savings every month and every year until you hit your expected retirement age. You also need the willpower to avoid jumping into hot stocks or risky sectors of the market and, instead, to continue to maintain your portfolio diversification.
As difficult as saving for retirement can be, you can use compound growth to help you achieve your goals while you save for your retirement.
Planning to never retire is not a realistic plan, because you may be forced into retirement unexpectedly.
The Power of Compounding
Even if you contribute the maximum amount to your Roth IRA every year and are incredibly disciplined in doing so over time, your contributions alone will not be enough to build that retirement nest egg. That’s why compounding is so important.
Compounding accrues on your contributions and the accumulated gains of that principal. In short, it’s gains on the gains that you’ve earned in the past. Compounding allows an invested sum to grow at a faster rate than simple growth, which is calculated on the principal alone.
The maximum annual contribution for a Roth IRA in 2023 is $6,500. That limit increases to $7,000 in 2024. People who are 50 or over may contribute an additional $1,000 catch-up contribution each year.
How Much Will My Roth IRA Be Worth?
Let’s look at an example using $13,000 in annual contributions. For simplicity's sake, let's assume that you and your spouse each only contribute $6,500 to a Roth IRA as a lump sum at the beginning of each year, which is the limit for 2023.
If your $13,000 deposit earns 8%, the simple growth for that year would be $960. Your accounts would collectively end the 2023 contribution year at $14,040 ($12,000 + 1,040). At the end of the next year, the combined balance would be $28,080 ($26,000 × 1.08) because you only earn returns on contributions.
Let’s say that your Roth IRAs grows at an 8%compoundedrate of return instead. At the end of the first year, you would have the same balance as if you earned simple growth: $14,040. But at the end of the second year, you would have $26,957 instead of $28,080 because of the extra growth earned on the first year’s gains ($13,000 + 14,040 = $27,040 × 1.08 = $29,203.20). It may not yet be a huge difference, but still more than the simple growth would yield.
Of course, the more years that pass, the greater the effect of compounding. Below, we list the total profit accrued over each subsequent year using the maximum contributions for 2023 and 2024 in the table below. Keep in mind that the contribution years in the table are independent of one another. This means the calculations for 2024 below do not factor in the earnings from 2023.
| Compounding in Years 1 to 5 | ||||||
|---|---|---|---|---|---|---|
| Maximum Contribution | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
| 2023 | $13,000 ($6,500 x 2) | $1,040 | $3,203.20 | $6,579.46 | $11,265.82 | $17,367.08 |
| 2024 | $14,000 ($7,000 x 2) | $1,120 | $3,449.60 | $7,085.57 | $12,132.41 | $18,703.00 |
Long-Term Impact of Compound Growth
Your account growth suddenly exceeds your annual contributions in the fifth year. As your account continues to grow, that increase gets greater and greater, eventually adding $67,746 to your account in Year 10. That’s 564% more than your annual contribution.
Granted, this is based on a fixed rate of return of 8% for 10 years in a row. In real life, the stock market and your investments will not see such steady returns. You could see 25% growth in some years, and 15% losses in other years. Still, 8% is the long-term ROI in the stock market, so it’s a reasonable average to target.
Your contributions will exceed what you put into the account on an annual basis over time. But just because your account grows more than $12,000 in a given year doesn’t mean that you should stop making contributions. A key component of growth is having a large contribution base. So stay dedicated and keep funding the account every year (to the maximum amount, if possible).
Develop a Well-Rounded Investment Plan
Will a Roth IRA be sufficient for you to build your $1.97 million nest egg? Probably not, since you could only contribute up to $6,500 a year for 2023 ($7,000 in 2024, since the Internal Revenue Service (IRS) periodically adjusts the limits for inflation). If you are older than age 50, you can make an additional contribution of $1,000 each year.
Roth Income Limitations
The Roth IRA has income limitations, which means that you may not be able to contribute to a Roth if you earn more than the limit. If this is the case, your contributions could be limited or phased out entirely. The income phaseout limitations also depend on your tax filing status.
You cannot contribute to a Roth IRA in 2023 if you were a single filer and earned more than $153,000. The income phaseout range for contributions is $138,000 to $153,000.That range increases to $146,000 to $161,000 for 2024, which means that you can’t contribute if you earn more than $161,000 in 2024.
For married couples who file a joint tax return, the Roth income phaseout range is $218,000 to $228,000 in 2023 and $230,000 to $240,000 in 2024. In other words, if you (and your spouse) make more than $228,000 in 2023, you cannot contribute to a Roth for that year. For 2024, the income limit is $240,000.
Combined Approach
A Roth IRA has valuable tax advantages, such as tax-free withdrawals in retirement and no required minimum distributions (RMDs). But this is only one part of a well-rounded retirement savings plan. If you have a 401(k) with your employer, that is another good option, particularly if your employer offers matching contributions.
You only get one shot at retirement planning, so it can be helpful to work with a qualified financial planner or advisor. An advisor will help you set goals for retirement and develop a plan to reach them.
What Is the Best Way to Fund a Roth IRA?
The best way to fund your Roth IRA is to invest the maximum amount permitted each year. It’s a bad idea to withdraw funds, which may incur penalties and taxes, if you withdraw the earnings before age 59½ and before the funds have been in the account for five years. Keep in mind that your contributions can be withdrawn at any time, penalty-free. This strategy allows you to benefit from compound growth—gains that are accrued on the gains previously earned. This results in higher earnings than simple growth.
Should I Contribute the Maximum Even When Market Prices Are High?
Generally speaking, yes. Even if you think stock funds are overpriced, it’s generally worth making the maximum contributions to your Roth IRA. The money will grow tax free, and the tax savings that you will eventually realize are likely to be far larger than the slightly inflated cost of stocks, shares, and funds.
Can You Get Rich From Compounding?
Yes. In fact, compound growth is arguably the most powerful force for generating wealth ever conceived. There are records of merchants, lenders, and various businesspeople using compound growth to become rich for literally thousands of years. More recently, Warren Buffettbecame one of the richest people in the world through a business strategy that involved diligently and patiently compounding his investment returns over long periods of time.
How Does the 5-Year Rule Work?
The Roth IRA five-year rule states that you cannot withdraw earnings tax free until at least five years since you first contributed to a Roth IRA. This rule applies to everyone who contributes to a Roth IRA, whether they’re 59½ or 105 years old.
The Bottom Line
The benefit of compounding is a great advantage, especially if you begin your savings and retirement plan early in your career. Being disciplined about the purpose of these savings, and not making early withdrawals that can incur penalties and fines, will help you reach your goals and provide a better retirement for you.
Researching what costs you will need to cover after you stop working (rent, healthcare, incidental expenses, taxes, emergencies) can give you a realistic idea of how much you should be saving to reach a comfortable retirement lifestyle.
Starting savings early is your magical way of self-funding your IRA. Compounding over the long term will help grow your retirement savings.
