Learn more about Roth IRAs versus index funds as we break down the investment jargon and show you why they’re both good vehicles for growing your nest egg.
What’s the Difference Between a Roth IRA and an Index Fund?
You may be wondering which is better: a Roth IRA or an index fund. But that’s a bit like asking which is better: a bank account or a wad of cash. Just as you keep your cash in a bank account, a Roth IRA is an account where you hold investments such as index funds and individual stocks and bonds. Let’s break it down a little further. Index funds are a common type of investment for Roth IRAs and other types of retirement accounts. An index fund is a basket of securities that tracks the performance of a market index. You can find index funds that invest across the overall stock market or bond market, or a specific segment of a market. For example, when you invest in an S&P 500 index fund such as the Vanguard S&P 500 ETF (VOO) or the SPDR S&P 500 ETF, (SPY), you’re investing across 500 of the largest companies in the U.S. The goal of the fund is to mirror the performance of the S&P 500 index as closely as possible. One of the benefit of investing in index funds is that you get automatic portfolio diversification. You’re investing across many different securities, which is a lot less risky than investing in just a couple of different securities.
Roth IRAs
To invest in a Roth IRA, you’ll need to choose a brokerage and fund the account. From there, you can decide how to invest your money. An index fund, which may be mutual funds or exchange-traded funds (ETFs), is just one option you can choose.
Who’s Eligible
To fund a Roth IRA, you need earned income, which is basically money you get from working. Your income also can’t exceed the Roth IRA income limits. For tax year 2022, these limits are $144,000 for a single filer and $214,000 for a married couple filing a joint tax return. A single filer whose income is between $129,000 and $144,000 and a married couple whose income is between $204,000 and $214,000 can contribute a reduced amount. For tax year 2023, these limits are $138,000 for a single filer and $218,000 for a married couple filing jointly. Single filers who make between $138,000 and $153,000 and married couples who make between $218,000 and $228,000 can contribute a reduced amount to their Roth IRA.
Contribution Limits
The Roth IRA maximum contribution you can make for tax year 2022 is $6,000 for people under age 50. The maximum contribution you can make for tax year 2023 is $6,500. People 50 and older can contribute an additional $1,000 in catch-up contributions.
Index Funds
You can invest in index funds with virtually any type of investment account. Investment accounts include Roth IRAs, traditional IRAs, Roth 401(k)s, traditional 401(k)s, and taxable brokerage accounts.
Who’s Eligible
There are no eligibility restrictions for index funds. As long as you’re eligible to open an investment account, you can invest in index funds. Retirement investment accounts have IRS rules you have to follow, while taxable brokerage accounts will allow you more flexibility.
Contribution Limits
There’s no limit on how much you can invest in index funds. However, you’re subject to the contribution limits of your investment account. For example, if you’re younger than 50 and your only investment account is a Roth IRA, you’d only be able to invest $6,500 in index funds for tax year 2023. But if you were to invest in index funds through a taxable brokerage account, there would be no limit to the amount you can invest.
Invest in Both
You don’t have to choose between a Roth IRA and index funds. A Roth IRA is an investment account, while an index fund is a type of investment you can choose for your Roth IRA or other investment accounts. In other words, you can open a Roth IRA and invest in index funds through that account. Both Roth IRAs and index funds are solid options for retirement savings. Investing in an index fund allows you to invest without putting too much of your money in any single investment. By investing in index funds within a Roth IRA, you allow your money to grow tax-free. As long as you follow the IRS rules, all the money in your Roth IRA will be tax-free when you retire.
