I think I've been using IRAs all wrong.

I read a while back about putting money into an IRA, so I opened up a Roth IRA and have been maxing out my contribution. I saw that there were opportunities to invest, but I was so new to the game that I decided to ignore those opportunities for the time being and just make sure that I have money going into the account.

A year later, I decided to think about what I was actually doing, and I came to the conclusion that putting money into an IRA without investing is useless, because the money in there is just cash that's losing value due to inflation.

So do you only benefit from an IRA if you invest the money? I've searched and searched, but haven't found sources explicitly saying you need to invest the money. With my 401k, I had no choice, but with the IRA, I do.

  1. If the whole benefit comes from investing, why is there even an option to not invest? (assuming that that's indeed the benefit)

  2. Should I generally be investing all of the money that I contribute (like I do with my 401k)? I have since put some of it into a lifecycle fund that's appropriate for my age, but I guess I would need to set it up, so that it auto-invests my contributions each month.

  • Paragraph one is a good start. Get in the habit of saving regularly. – Pete Becker Mar 16 '18 at 12:53

So I think you understand the general premise. Generally, the issue is taxation. Taxation of the income used to contribute, taxation of distributions, and taxation of income generated from the funds in the account.

In a traditional account, you shield your current income from taxation, the funds grow in the shelter of the account free of tax, the funds are taxed as income upon distribution.

In a ROTH arrangement, you don't shield your current income from taxation, the funds grow in the shelter of the account free of tax, and the distributions are untaxed.

So obviously, if your ROTH funds are not invested somehow, there is little benefit. The funds were already taxed before contribution, and there is no gain that was permitted to grow untaxed. It is worth noting that you are permitted to take your contributions back out of a ROTH arrangement without penalty, an option not available to traditional retirement arrangements. So, you have not realized the typical benefit of growth without taxation, but, there's similarly no harm letting your funds sit in a retirement account.

However, one often overlooked benefit associated with retirement accounts is robust general protection from creditors, even in bankruptcy. So contributing to a ROTH even if it will sit as cash isn't really a BAD idea, since it's more protected than a non-retirement account, and you can get your contributions back later if you want.

You don't necessarily have to apply risk to the money if that's how you'd like to allocate your portfolio.

  • +1, for the bankruptcy protection point. – Dustin Mar 16 '18 at 10:15

Yes, you would want to invest the money that you put into Roth IRA, in about the same way as you do with 401(k). Conceptually, all these are containers, inside of which you can hold your assets.

Note that with Roth IRA, you often have many more investment options available to you, than you do with 401(k). They often come with lower expense ratios, too.

If you kept all your money in cash inside Roth IRA, then you essentially used it as an awkward savings account.

Roth IRA is one of the types of the so called "tax advantaged" accounts, which means that you are not paying taxes on the growth of your capital inside the account. Putting money in Roth IRA, and not letting it grow, is a waste of this opportunity.

As for why there is an option not to invest, technically, you are still investing your money, in the sense that you are buying some type of financial asset. What you probably mean is some kind of money market fund. While it offers no growth, it also comes with no risk of losing value. Essentially this is a cash reserve inside your account, which may be convenient for the accumulation of dividends, or for moving the money in and out of the account.

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