How Does a Roth IRA Grow and Build Wealth?

There’s a reason a Roth IRA is a popular retirement savings tool. It allows you to access a wide range of investments and enjoy tax-free distributions in retirement. Roth IRAs also use the power of compound interest to grow your nest egg—but choosing the right investments is key.

We’ll help you understand how a Roth IRA works and why it can be a good retirement savings option, especially if you’re young and just starting to save.

How does a Roth IRA work?

A Roth IRA is a type of individual retirement account (IRA) you can use to save for retirement. Contributions to a Roth IRA are made after tax, which means you won’t be taxed on the money when you withdraw it in retirement.

If you’re young and in a lower income bracket, a Roth IRA can be an especially attractive option: You’ll pay taxes now, when you’re likely in a lower income bracket, and not pay taxes later, when your income (and tax rate) will probably be higher.

There are other types of IRAs you can use to save, too. With a traditional IRA, you contribute pre-tax dollars and pay taxes on the withdrawals. You’re also able to deduct a portion of your contributions to a traditional IRA, so there are other tax benefits to contributing to one.

Whether a Roth IRA fits in your retirement plan will depend on what else you’re doing to save. If your employer offers a Roth 401(k), you may be able to reap tax benefits there. It’s important to look at your plan as a whole when deciding how to save for retirement.

How does a Roth IRA grow?

There are generally two ways to grow the balance on your Roth IRA: by making contributions and by investing those contributions. Here’s how it works:

Contributions

When setting up your Roth IRA, you’ll decide how often you want to make contributions and how much you want them to be. It may seem fairly obvious, but your Roth IRA will get bigger as you put more money into it over time.

In 2024, you can contribute up to $7,000 per year to any IRA—traditional or Roth. (Folks who are 50 or older can kick in an extra $1,000.) However, if your income is above a certain amount, you may not be able to make contributions to a Roth IRA (or your contribution limit may be reduced). In 2024, this is true if you’re single and earn more than $161,000 a year ($240,000 if you’re married filing jointly).

Investment gains

When you contribute to a Roth IRA, your contributions can be used to purchase a variety of investments—including stocks, bonds, mutual funds, exchange-traded funds (ETFs) and more. Depending on the performance of those investments, you can earn interest and dividend payments, which will further grow your savings. Your IRA can also earn money if you sell assets in the account for more than you paid for them. This is known as capital gains.

As long as you make a qualified distribution (which for most people means waiting until age 59½ to withdraw earnings), you won’t have to pay taxes on any investment gains in your Roth IRA. If you pull earnings out early, they may be subject to tax and an early withdrawal penalty, depending on how you plan to use them.

How much does a Roth IRA grow in a year?

It depends on market conditions and the investments you hold in your Roth IRA. Holding more stocks than bonds could lead to faster growth, but you’re also assuming more risk. The right asset allocation for you will depend on your risk tolerance and goals. With that said, since 1970 the S&P 500 has had an annualized total return of over 10 percent.

How does compound interest work with a Roth IRA?

As you invest in a Roth IRA, you’ll earn interest on both your principal balance and interest that’s already accrued in the account. That’s called “compound” interest—which gives growth on growth. Any dividends you deposit and any increase in your investment value will also earn compound interest. All in all, using an account like this can put some serious muscle behind your retirement savings.

Let’s say you put $500 per month into a Roth IRA for the next 30 years. You will have contributed $180,000 total—but if you get a 6 percent annual return, your balance could be north of $500,000 in 30 years.

What other retirement accounts can I use with a Roth IRA?

A Roth IRA can help grow your retirement savings, but relying solely on a Roth IRA in retirement can have limitations. Its lower contribution limits make it difficult to save as much as you’ll need, and high-income earners may not be able to contribute directly at all.

A good retirement plan will rely on a mix of financial options—playing on the strengths of each. Here are some other retirement savings accounts you might use alongside a Roth IRA to build compound interest and supercharge your savings.

401(k)

This employer-sponsored investment account allows you to contribute up to $23,000 per year (or $30,500 if you’re 50 or older). Unlike a Roth IRA, the money you put into a 401(k) is tax-deductible, which can reduce your taxable income while you’re still working. However, you’ll be taxed on withdrawals you make in retirement. (Your company may also offer a Roth 401(k), in which contributions are taxed and withdrawals down the road could be accessed tax-free.) A 10 percent penalty applies to distributions taken before age 59½.

A traditional IRA

As with a 401(k), distributions from a traditional IRA count as taxable income. Your contributions may also be tax-deductible. In 2024, you can contribute up to $7,000 across all your IRAs (including Roth accounts) each year. That number jumps to $8,000 if you’re 50 or older. Taking money out of a traditional IRA before age 59½ will trigger a 10 percent penalty.

Nonqualified (after-tax) accounts

This type of investment account doesn’t offer the tax advantages of a 401(k) or IRA, but it can provide a source of income in retirement. You can open a brokerage account to buy and sell all kinds of securities. Just be aware that you’ll be taxed on gains during the year they’re realized. The upside is that there are no withdrawal limitations or penalties. In addition to a brokerage, you could choose to work with a financial advisor to manage your investments for you (meaning they’ll make decisions on your behalf).

A Northwestern Mutual financial advisor can provide personalized guidance based on your risk tolerance and financial goals. They can also help you see how a Roth IRA integrates into your overall investment plan.

This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.