New investors often wonder if a Roth IRA or a mutual fund is the better choice for their money. It's impossible to give a satisfactory response, as it would be like trying to compare apples with oranges. Roth IRAs and mutual funds are two very different investment vehicles. Roth IRAs are not investment vehicles like mutual funds.

The term refers to a specific category of bank accounts. A Roth IRA can hold various investments, including stocks, bonds, cash, and mutual funds. If you know how a potential investor may set up a Roth IRA, you'll have a better grasp of how they function and differ from mutual funds.

The Inner Workings of a Roth IRA

The federal government established the Roth IRA as a retirement savings vehicle. There are several key distinctions between this and a conventional IRA. Each year, you can set aside a maximum amount. Roth IRA contribution limits for 2021 and 2022 are $6,000 for those under the age of 49 and $7,000 for those 50 and over.

The contributions you make to a Roth IRA are not tax deductible. It's the same as putting money into a savings account. However, the growth of dividends, interest, and capital gains within a Roth IRA are entirely tax-free.

Limits on Roth IRA Eligibility

The maximum annual income allowed for Roth IRA contributions is established by law. According to the rules, if you are single and make $144,000 or over in 2022, you will not be able to make a Roth IRA contribution. From $140,000 in 2021, we have an increase of $9,000. The income cap for joint filers with spouses rose from $208,000 in 2021 to $214,000 the following year. 56

If your income is higher, you are still eligible to contribute to a conventional IRA because there is no maximum income threshold for traditional IRA contributions. It's possible to switch to a Roth IRA afterward. Here, we have a "backdoor Roth IRA," short for Individual Retirement Account.

Getting Started With a Roth IRA

Roth IRAs can be found at a wide variety of financial establishments. Using a Roth IRA from a bargain broker like Charles Schwab, you may invest in stocks, bonds, and mutual funds. When opening a Roth IRA with a bank, you may be limited to investing in the money market and certificate of deposit accounts. If you open a Roth IRA with a mutual fund firm, you will likely be limited to investing in the firm's funds.

Roth IRAs at banks or credit unions

Let's say you've decided to start a Roth IRA at your neighborhood credit union. You can only put money into savings accounts or certificates of deposit with the credit union; there is no investing department. This Roth IRA cannot be used to invest in equities, bonds, mutual funds, or real estate as the servicer does not provide these options.

You may open a Roth IRA and invest in stocks, bonds, and mutual funds offered by other firms through the brokerage arms of some banks and credit unions. Some examples are Wells Fargo and Bank of America.

Setting Up a Roth IRA Through a Mutual Fund Distributor

Let's imagine you're interested in investing in the TBGVX. Eleven ticker symbols of the Tweedy, Browne International Value Fund. You download an application from the mutual fund company's website, mark the "Roth IRA" box, and then send a $6,000 check. Because you are under 50 years old, this is the maximum amount you may donate in 2022.

In this case, the mutual fund firm will form a Roth IRA for you, but you will be limited to purchasing shares in funds managed by Tweedy, Browne & Co., LLC. If you ever want to invest in the Vanguard S&P 500 Index Fund or Coca-Cola, you'll have to make alternative plans.

Direct Stock Purchase Plan Roth IRA Openings

Your plan now is to use your Roth IRA to invest in shares of The Coca-Cola Company and hold them indefinitely while reaping the tax benefits of doing so. If you don't want to put your money in a mutual fund or ETF, then the direct stock purchase plan with a Roth IRA is your only choice.

When you link your checking account to your Roth IRA, the transfer agent for the soda giant will automatically deduct a fixed amount from your account each month to acquire more shares of Coca-Cola at a deeply discounted price. Average transaction fees are less than $2. If you own Coca-Cola stock in a Roth IRA, you will never have to pay taxes on your dividends.