Best Ways to Boost Yields Inside Your Roth IRA

You've saved some of your money in Roth IRAs. What's your plan? Have you thought much about how to invest the money that's inside your Roth IRAs to get the best yields for your situation?

Your decisions depend on four main considerations, experts say.

• Your total assets for retirement. What other accounts and sources of income do you have for retirement?

• Your cash reserve or emergency fund. Have you established an emergency fund or rainy-day reserve of one to two years' expenses?

• Your risk tolerance. How comfortable are you with risk? Would you panic if the market made a correction of 10% or more?

• Your time horizon. When might you need to tap the Roth IRA money?

How you invest inside a Roth IRA is "going to depend on when you are going to tap this money," said Greg McBride, chief financial analyst for Bankrate.com, a personal finance website. "If your Roth IRA is money that you don't need to tap right away in retirement, it can act as a form of longevity insurance. You can literally defer (withdrawing) it 'til your 80s or 90s if you don't need that money. So, you have the ability to invest (it) more aggressively."

Taxes on money you invest in a Roth IRA are paid "on the front end," said Rob Williams, a managing director at the Schwab Center for Financial Research. So, when you withdraw funds after age 59½ and as long as the funds have been in a Roth IRA account that was opened at least five years ago, the money can be withdrawn tax-free.

"You can take any amount from the Roth IRA without having a higher tax bill," said Williams. "It's a very nice thing for your future self, if you can afford it." Remember: you have to pay tax on the contributions upfront.

Earnings in Roth IRAs include interest, dividends and growth or unrealized gains. All can be withdrawn tax-free as long as these conditions are met. You are not required to take RMDs (required minimum distributions) from a Roth IRA, as you are with other retirement-savings accounts.

Consider Roth IRA money as just one part of your retirement plan.

"Don't look at the Roth in isolation," Williams said. "The most effective approach is to look at all the pieces" of your retirement as part of a comprehensive plan.

What will your sources of income be in retirement? Depending on your situation, they can include Social Security retirement benefits, a pension or more than one, brokerages accounts — interest and dividends — and possibly rental income from investment properties.

In addition, it's essential to have an emergency fund. "That's a protection that prevents all of your other investments from having to be liquidated," said Daniel Lee, director of financial planning and advice at BrightPlan, a financial advisory and wellness benefit provider in San Jose, California.

An emergency fund means money for a new roof, an unforeseen dental or medical expense not completely covered by insurance, or a major vehicle repair. Any cash cushion that is not invested in equities creates more flexibility in retirement without tapping investments. "It gives you a buffer so that if markets are down and you want to fund your lifestyle you can tap into that cushion," said Roger Young, thought leadership director at T. Rowe Price.

The Roth IRA is the last money to use in retirement. Money in a Roth IRA is taxed before you deposit it, but the interest, dividends and capital gains all grow tax free. Money saved in other retirement savings plans, such as 401(k)s, are not taxed until you withdraw it, meaning you will pay taxes on the amount you save as well as all interest, dividends and capital gains you earn. Postponing spending of your IRA allows you to earn more without paying taxes on it.

If you are entering retirement or already in retirement, for example, and you are past age 62 or 70, have claimed your Social Security, and you have one or more workplace pensions, these sources of income may cover your essential or guaranteed monthly expenses. So, the money in the Roth IRA would be the last money you tap in retirement.

"If you don't think you're going to need money from the Roth IRAs, you can invest more aggressively," Williams said. A greater percentage of stocks versus fixed income investments is possible rather than 60/40 stocks to bonds. "You can invest more heavily toward stocks," Bankrate's McBride said.

That said, target-date retirement funds are an option for Roth IRA money. These are investments that automatically set to a more conservative mix as they approach the target year typically named in the fund such as Target 2030 or Target 2040.

If you expect you will not need this money until your 80s or beyond or you intend to leave it as a legacy for your heirs, you can invest in a target date fund with a much later date. For example, if you are aged 65 and don't plan to use the Roth IRA money for 15 years, you could pick a target date fund for 2040 or 2045, when you will be 80 or 85. "The key here is aligning the target retirement funds with the date you plan on making withdrawals," McBride said.

When choosing investments to hold in your Roth IRA, be sure to check the expense ratio on any mutual fund or exchange-traded fund (ETF) you consider. The expense ratio measures how much of a fund's assets are used each year for administrative and other operating expenses. An expense ratio of 0.05% for an actively managed mutual fund is low.

In contrast, if you are aged 70, for example, and know you likely will need to take withdrawals from a Roth IRA sooner rather than later, take a "much more conservative" approach to the investments you make in your Roth, McBride said. A 50/50 stock-to-fixed income allocation might be more appropriate.

Passive investors who prefer to hold investments for a relatively long period of time might choose S&P 500 Index funds or Total Stock Market Index funds. S&P Index Funds are a mix of the largest 500 U.S. companies, a broad-based fund good in any account, said McBride. "Broad-based low-cost funds are the path that will deliver the best results," he added.

However, S&P 500 Index funds don't invest in small or midsize companies. Total stock market index funds offer broader diversification by including large, midsize and small U.S. companies.

In summary, index funds mirror all or part of the stock market. They are typically passively managed, so investors don't have to pay an active fund manager.

"Low-cost passive index funds — that's the best way for individual investors to keep pace with market benchmarks," McBride said.

What about some international exposure? "In the last 10 years-plus, the U.S. has outperformed international" investments, said Young, of T. Rowe Price. "It's hard to predict whether that trend is going to continue or not."

Overall, Young said, "The Roth is a great place for investments with a lot of growth potential."

Depending on when and if you stop working, retirement can last 20 to 30 years. "It's better to plan for a longer horizon and have money to last your lifetime than outlive your money," said McBride.

Harriet Edleson is author of the book, “12 Ways to Retire on Less: Planning an Affordable Future” (Rowman & Littlefield). A former staff writer/editor/producer for AARP, she has written for The New York Times, The Washington Post and Kiplinger's Retirement Report. Read More