Can You Lose Money in a Roth IRA?

Summary:

Yes, you can lose money in a Roth IRA due to market fluctuations and early withdrawal penalties. Since these accounts are meant for retirement, you can also lose money if you withdraw from your Roth IRA before the account matures. To avoid these problems, don’t withdraw from your Roth IRA until after 59½, diversify your investment choices, and don’t pull money from your account too hastily.

Even though there are numerous retirement accounts to choose from, Roth IRAs remain a popular option and serve as a great investment vehicle for those looking to build wealth into retirement. One of the biggest reasons for this is that Roth IRAs are funded using after-tax dollars. This is important to note because you won’t have to pay taxes on those funds when you use them during retirement.

So, if you’ve already paid taxes on this money, can your Roth IRA ever decrease? Is this a sign you should remove your funds? Well, not exactly. In this article, we’ll take a look at Roth IRAs, what it means if your Roth IRA begins to lose money, and what to do once you notice this happening.

What is a Roth IRA?

A Roth IRA is a type of individual retirement account (IRA) that allows you to save for retirement on a tax-free basis. Contributions to a Roth IRA are made with after-tax dollars, which means qualified withdrawals from a Roth IRA are tax-free.

One of the key features of a Roth IRA is that it allows you to make contributions even if you are earning too much to contribute to a traditional IRA. There are income limits for Roth IRA contributions, but they are typically higher than the limits for traditional IRAs.

Can you lose money in a Roth IRA?

To put it simply: Yes, you can lose money in a Roth IRA. But that applies to all investment vehicles. Don’t blame the Roth IRA. It’s all about the assets you choose to invest in. It certainly doesn’t mean it’s a bad idea to open a Roth IRA.

Every investment comes with some percentage of risk. Roth IRAs are no different, and there’s a possibility that you’ll lose money over the course of your investment. Again, it depends on the assets you invest in, not the Roth IRA. Roth investments allow you to invest in most financial assets, including stocks, bonds, mutual funds, and ETFs. However, you can’t invest in life insurance, cryptocurrency, and collectibles. That said, it’s important to remember that, with a Roth IRA — and any investment, really — you have to be patient. Most investments are not get-rich-quick schemes and require knowledgeable decisions and patience in order to see any return.

Since losing money is generally an investor’s primary concern, we’ll examine three ways that you can lose money in a Roth IRA:

  1. Early withdrawal penalties
  2. Market fluctuations
  3. Not letting your investment grow

1. Early withdrawal penalties

When investing in a Roth IRA, a common way that many people lose money is by withdrawing their money too early. Withdrawing money before hitting retirement age, or prior to having the account for a five-year period could cost you 10% in fees. To avoid these fees, make sure you avoid withdrawing from your Roth IRA before you turn 59½.

Meeting with a financial advisor can give you a full rundown of the fees and penalties associated with withdrawing your Roth account funds early.

2. Market fluctuations

Every investor knows there is a level of risk when investing, even with a Roth IRA. The stock market constantly fluctuates, and withdrawing money during a dip in the market may mean the account holder loses funds.

If one of the businesses that you’ve invested in goes out of business, you’re going to lose money regardless of whether you use a Roth IRA, a 401K, or a traditional IRA. During an economic downturn, your Roth IRA may lose a significant amount of its value. This is particularly true if you’re not investing in an adequate number of companies or if your investment portfolio isn’t diversified.

Instead of trying to pick stocks, it’s a good idea for most investors to have a well-diversified portfolio that includes a wide selection of assets. Mutual funds, ETFs, and index funds provide a cost-efficient way of creating a diversified portfolio. If one of your chosen investments goes down, you won’t risk all of the money in the account since your dollars are spread out amongst multiple different channels.

Related reading: To learn more about your investment options, take a look at our articles on the different types of investment vehicles.

3. Removing money before it has the chance to grow

The earlier an individual begins investing their money, the better. And the longer money sits in an investment account, the more time it has to grow. With this in mind, it makes sense that withdrawing funds before they’ve had time to grow isn’t beneficial to the account holder.

As with most investments, there is a chance that you’ll lose money in a Roth IRA. However, it is generally not a good idea to remove money from your Roth IRA just because it has started losing money. Although you may want to rebalance your portfolio if you realize its risk does not align with your goals and personality, there are good reasons to think twice before removing money from your Roth IRA. There are, for example, tax implications to consider. When you make contributions to a Roth IRA, you do so with after-tax dollars, meaning you have already paid taxes on the money you contribute. Withdrawals from a Roth IRA are generally tax-free, as long as certain conditions are met. If you withdraw money from your Roth IRA when it is losing money, you will not be able to recoup the taxes you paid on your original contribution.

To get a better idea of whether a Roth IRA is right for your retirement plans, consult an investment advisor.

Other ways to minimize risk

Just as you can lose money in an investment, you can also take steps to minimize this possibility. For instance, in addition to the steps above, consider making several small contributions to your Roth IRA.

You can do this through the dollar-cost average method of investing, which allows you to invest small amounts of money over time. This method generally requires a monthly or quarterly investment and minimizes risk over the course of your Roth IRA.

It is possible to lower your risk of losing the principal of your investment to practically zero if you invest in Roth IRA CDs. A Roth IRA CD is a certificate of deposit that’s held inside a Roth IRA (no great surprises there).

Another way to minimize risk is with a Roth IRA fixed index annuity. The biggest advantage of a Roth IRA fixed index annuity is that your eligible contribution will not lose money if the stock market declines. Instead, you can invest in a variety of asset classes while protecting your principal amount and continuing to earn money on your investment.

However, it’s important to note that the return on a fixed index annuity is not guaranteed and may be much lower than the index itself. Also, fixed index annuities can be complex (and expensive) financial products. It can be difficult to understand all of the terms and conditions associated with them. So, it’s a good idea to carefully review the terms of any fixed index annuity — preferably with a financial advisor that doesn’t make a living selling annuities.

Are Roth IRAs a safe investment?

Every investment comes with a level of risk. Even though Roth IRAs are considered a safer option when comparing retirement investments, keep in mind that there’s still some risk. Before committing to a Roth IRA, be sure to compare all of the benefits and downsides that come with this kind of retirement account.

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and drawbacks to consider.

Pros
  • Tax-free growth. Your money grows tax-free and you don’t have to pay taxes when withdrawing the funds. These tax advantages can be advantageous if you find yourself in a higher tax bracket during retirement.
  • More diverse investing options. Roth IRA owners have the power to choose which mutual funds or stocks to invest in. There is no third party choosing the investments for you.
  • Independent account that is not tied to an employer. A Roth IRA can be opened at any time and does not need to be rolled over if you change employers. You can take advantage of your employer’s 401(k) or 403(b) retirement plan and still put money in a Roth IRA. That said, you may still want to roll your 401(k) over into an IRA if you leave that company.
  • No RMDs. Unlike a traditional IRA, a Roth IRA does not have any required minimum distributions (RMD). This means your money can stay in a Roth IRA for as long as you’d like.
  • Spousal IRA. Even if only one spouse earns money, both can benefit from a Roth IRA account and invest money for retirement.
Cons
  • Early withdrawal rules. If you choose to withdraw money before you’ve had the account for five years and before you turn 59½ years old, you may be subject to penalties and fees.
  • Contribution limit. Regardless of how much money you can contribute, your Roth IRA contribution limit is determined by your modified adjusted gross income (MAGI) and tax filing status.
  • Income limits. If your income is $153,000 as a single person or over $228,000 as a married couple filing jointly, you are not eligible to contribute to a Roth IRA in 2023. However, these limitations vary from year to year, so be sure to check these limits annually.

Roth IRA contributions

Contributions limits for Roth IRA accounts change each year, so make sure you stay updated on the new limits annually. For updates on this information, take a look at our article on Roth IRA contributions and the IRS’s website.

Additional retirement investment options

There’s no one-size-fits-all investment option for retirement. It really depends on your unique financial needs and goals. It’s even possible to have more than one retirement fund at a time. This has many benefits, including tax diversification.

Since everyone’s financial situation is different, your savings needs will differ from the next person. Options for your retirement savings include traditional IRAs, 401(k), and 403(b) accounts, to name a few. Learn about more retirement account options here.

Outside of traditional retirement accounts, there are many other ways to save money for retirement — including options for self-employed individuals and contributing to a health savings account. The key with saving for retirement is starting as soon as you can. Financial experts recommend having eight times your annual pay saved by the age of 67.

Saving for college

Even if you’re in full-on retirement savings mode, you may be wondering about an education fund for your children. A 529 plan is one of the most common college saving funds, but there are other options.

For instance, a Roth IRA can be used to save money for your children’s college fund and comes with many benefits that a 529 college savings plan does not. These perks include the flexibility to switch the account over to a general investment account if your child decides not the attend college.

FAQs

How fast does a Roth IRA grow?

A Roth IRA grows, on average, 7% to 10% each year. There are several factors that determine how much your money grows annually, including what investment vehicles your Roth IRA contains. For advice on your individual situation, speak with an investment or financial advisor.

Is a Roth IRA or 401(k) better?

This is a bit of a gray area, as both a Roth IRA and a 401(k) are great retirement accounts. While neither is “better” than the other 100% of the time, you may find that one account suits your retirement plan better than another.

A 401(k), like a traditional IRA, is funded using pre-tax dollars, meaning you’ll have to pay taxes on any money when you withdraw it. Most employers will also match an employee’s 401(k) contributions up to a certain percentage, meaning you could grow your retirement fund even faster. In addition to this, 401(k)s also have a significantly higher contribution limit.

With all this in mind, it may be best to contribute to both a Roth IRA and 401(k) rather than only one or the other.

Is my money protected in a Roth IRA?

Yes, your money is insured by the Federal Deposit Insurance Corporation (FDIC). However, the FDIC can only insure up to $250,000 across all of your IRAs. That means if you have multiple IRAs (either traditional, Roth, or a combination), only $250,000 across all accounts is FDIC-insured.

IRAs are also protected in the case of bankruptcy, though this protection varies depending on the type of IRA you have. Under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), both traditional and Roth IRAs have protection. However, this protection only applies to $1 million in assets.

Key Takeaways

  • Roth IRAs can lose money through market fluctuations and early withdrawal penalties. Your Roth IRA may also lose money if you don’t let your long-term investments mature.
  • To avoid losing money in a Roth IRA, don’t withdraw your funds before you become 59½, and be sure to diversify your investments.
  • Despite the potential to lose money, Roth IRAs are generally considered a safe option for retirement investments.
  • A financial advisor or investment advisor can help you determine the best type of retirement account for your personal situation.
View Article Sources
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