Roth IRAs and index funds are both valuable tools for building wealth, but there’s a key difference: A Roth IRA is a type of investment account used to save for retirement, while an index fund is a type of investment. In fact, index funds are a common type of investment within Roth IRAs and other types of retirement accounts.
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.
Key Takeaways
- A Roth IRA is a type of tax-advantaged retirement account, while an index fund is a type of investment that tracks a market index.
- Index funds are popular choices for Roth IRAs and other investment accounts.
- A Roth IRA is a popular choice for investors because withdrawals are tax-free in retirement.
- One of benefit of investing in index funds is automatic portfolio diversification.
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.
| Roth IRA | Index Fund | |
|---|---|---|
| How to invest | Open a Roth IRA at a brokerage of your choosing | Open an investment account, fund it, and choose an index fund |
| Who is eligible | Anyone with earned income, although income limits apply | Anyone with an investment account |
| Contribution limits (2022) | $6,000, or $7,000 if you’re 50 or older | Not applicable |
| Contribution limits (2023) | $6,500, or $7,500 if you’re 50 or older | Not applicable |
A Roth IRA is a type of individual retirement arrangement (IRA), but it’s commonly referred to as an individual retirement account. You contribute after-tax money to a Roth IRA, meaning you don’t get a tax deduction for your contribution. However, if you follow the rules, your money grows untaxed and is tax-free when you take distributions when you’re 59 ½ or older.
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 such as the Vanguard S&P 500 ETF (VOO) or the , (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.
Note
Most index funds are passively managed, which means investment managers aim to mirror the performance of the benchmark index, rather than outperforming it. With an actively managed fund, managers attempt to beat the benchmark index.
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.
Frequently Asked Questions (FAQs)
How much should I put in my Roth IRA per month?
For tax year 2022, the maximum amount you can put in your Roth IRA each year is $6,000, or $7,000 if you're over 60. That would mean putting in an average of $500 or $583.33 each month. For tax year 2023, the maximum amount you can put in is $6,500, or $7,500 if you're over 60. That would mean putting in an average of $541.67 or $625 each month. If you cannot afford to put that much in, just put in as much as you can. Small investments can also help you grow wealth.
Can you invest in the S&P 500 with a Roth IRA?
You can invest in an S&P 500 index fund, like the Vanguard S&P 500 ETF (VOO) or the SPDR S&P 500 ETF (SPY) within a Roth IRA account. You just need to set up and fund your Roth IRA, and then you can purchase any available index funds.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
Internal Revenue Service. "Traditional and Roth IRAs."
Vanguard. “Vanguard S&P 500 ETF (VOO).”
Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”
Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2023.”
Internal Revenue Service. “Retirement Topics - IRA Contribution Limits.”
