How does a Roth IRA grow? (2024)

Key points

• Roth IRAs are tax-advantaged retirement accounts available to workers under a certain income.
• Roth IRAs grow through a combination of annual contributions and investment earnings.
• Roth IRA growth depends on your investment choices, your time horizon and other factors.

As you plan for retirement, a tax-advantaged account can improve your long-term investment growth by saving you money on taxes, either upfront or during retirement. One of the most popular accounts with such a tax advantage is the Roth individual retirement account.

“The Roth IRA is one of my favorite investing vehicles and adds to the value of a comprehensive retirement plan by adding tax diversification,” said Kevin Chancellor, a financial planner and the CEO and founder of Black Lab Financial.

Roth IRAs offer plenty of benefits, including long-term tax advantages and the ability to exercise full control over your investments. You can also see exponential growth in your Roth IRA thanks to compounding interest and investment returns.

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What is a Roth IRA?

A Roth IRA is an after-tax account, meaning your contributions aren’t deductible in the year you make them. But your money grows tax-free in the account for as long as you want. You can withdraw the earnings tax-free once you reach age 59½ as long as it’s been at least five years since your first contribution.

Tip: You can withdraw your Roth IRA contributions anytime tax- and penalty-free.

Unlike a 401(k), a Roth IRA is a self-managed plan, meaning you open and manage your own account.

“These accounts are common enough to be opened at your local bank or credit union but are most often initiated at a large brokerage firm like Schwab, Fidelity or Vanguard,” said David Ybarra, a certified financial planner and an advisor with Consilio Wealth Advisors.

You can contribute the full amount to a Roth IRA if you are single and have an income of less than $146,000 or are married and have a combined income with your spouse of less than $230,000.

Workers with higher incomes may be able to contribute a reduced amount. But once your income reaches $161,000 if you’re single or $240,000 if you’re married, you can’t contribute at all.

The IRS allows you to contribute $7,000 to a Roth IRA in 2024, with an additional $1,000 catch-up contribution if you’re 50 or older. The limits are adjusted for inflation over time.

How do Roth IRAs grow?

“Getting a Roth IRA to grow is a two-legged process. The first step is getting money in the Roth account, and the second is getting it invested,” Ybarra said.

If you contribute $7,000 each year for 40 years, you will end up contributing $280,000 to your Roth IRA.

But the more important Roth IRA growth comes from your investment earnings. A Roth IRA isn’t an investment in and of itself. Instead, think of it as a vehicle that holds individual investments.

A Roth IRA can hold a variety of investments. Your greatest limitation may be the brokerage firm you choose. Examples of investments you might find in a Roth IRA are:

• Stocks.
• Bonds.
• Mutual funds.
• Exchange-traded funds.
• Money market accounts.

Over time, your account will grow through a combination of capital gains, dividends and interest, which can result in exponential growth over your working years if sustained for years or decades.

How much does a Roth IRA grow?

The amount of growth your Roth IRA can experience depends on several factors, including your investment choices, your time horizon and market performance.

First, the investments you choose for your Roth IRA will significantly impact its growth. According to the Securities and Exchange Commission, the stock market has historically provided roughly 10% average annual returns. But stocks can be volatile, which creates an increased risk, particularly when investing in individual stocks rather than broad-based funds. Thus, some investors may feel uncomfortable investing too much of their portfolio in stocks.

On the other hand, some kinds of bonds, money market accounts and cash are considered safer investments because they’re less likely to lose money. But with this reduced risk comes a lower return that could affect your ability to reach your retirement goals.

Most experts recommend a mix of high- and low-risk investments in your portfolio. This diversification can hedge your losses when the market is down while ensuring adequate growth. And as you get closer to retirement, experts generally recommend reducing your overall portfolio risk, increasing the ratio of low-risk investments and decreasing the ratio of high-risk investments.

A target-date fund is a retirement investment fund that automatically optimizes your portfolio risk based on your time horizon. The further you are from the target date, the higher the risk of the fund. The fund’s risk is gradually reduced over the years until it reaches the target date, usually the year you’re projecting for retirement.

Another factor that impacts your Roth IRA growth is the market environment. Two investors could make identical investment decisions during different periods and end up with wildly different results.

For example, suppose someone invested solely in the S&P 500 from Jan. 1, 1973, to Dec. 31, 2012. During that time, their average annual return would have been 6.43%. Let’s say another person made the exact same investment but from Jan. 1, 1983, to Dec. 31, 2022. Their average annual return would have been 8.62%.

Your time horizon also affects your Roth IRA growth. The longer you leave your money invested, the more time compound interest has to work.

“Starting early and allowing your investments to compound over a longer period can potentially lead to more substantial growth,” said Chad Willardson, a certified financial fiduciary, chartered retirement planning counselor, and the president and founder of Pacific Capital. “Conversely, withdrawing funds before the age of 59½ (with some exceptions) can lead to penalties and limit the growth potential.”

Example of Roth IRA growth

The best way to understand the power of a Roth IRA is to see the math in action. Suppose you start investing $7,000 per year — roughly $583.33 per month — in a Roth IRA at age 25. You continue investing that amount until you retire at age 65, totaling $280,000 in after-tax dollars.

But assuming your returns equal the 10% average annual stock market returns touted by the SEC, you will retire with more than $3.09 million in your Roth IRA.

Here’s where the Roth IRA tax advantage comes into play: You won’t pay income taxes on that $2.87 million. If you had invested in a traditional IRA instead, you would owe income taxes on any withdrawals, considerably reducing the amount available to you.

Tip: If you’re in a higher income bracket, the upfront tax breaks traditional IRAs offer could be more beneficial than tax-free withdrawals in retirement.

Bottom line

A Roth IRA is a popular tax-advantaged investing tool, especially among young workers who don’t need an upfront tax break. By maxing out your contributions, investing responsibly and allowing your money to grow for as long as possible, you can retire a millionaire — or even a multimillionaire, as our example shows — by using a Roth IRA.

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