Smart young savers know to participate in their companies’ 401(k) plans as soon as they join the workforce to benefit from as many years of saving and compounding as possible. But really smart young savers should know to save via a Roth IRA, too.
The Roth IRA is such an important retirement investment tool that it now has its own holiday. On March 27, Jeff Rose, financial planner and GoodFinancialCents.com blogger, hosted an online event, the Roth IRA Movement, which he plans to make an annual celebration. He rallied other personal-finance writers to spread the word about the star savings account and inspire rookie investors to open their own accounts. “Overall, the turnout was awesome,” Rose said. “Several people have already emailed me and said that someone they know opened a Roth IRA because of reading a post about it.”
Here are some key lessons from the inaugural movement:
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You can open a Roth no matter how young you are, as long as you have earned income. Peter Anderson points out in his Roth IRA Movement contribution: “There isn’t an age limit to have a Roth IRA, so even your children can have one!” They can, that is, as soon as they make money working, whether it be baby-sitting, lawn mowing, working retail or whatever. And it’s super-easy to open a Roth through your bank. Also, TD Ameritrade requires no minimum initial investment and charges no maintenance fees. For your application, you’ll just need your Social Security number, your employer’s name and address, your checking or savings account number and bank routing number (if you want to fund the Roth IRA electronically), and your beneficiary’s address and Social Security number.
You can withdraw Roth IRA contributions whenever you want, tax- and penalty-free. On his site, financial planner Tim Maurer writes about “The Three Guarantees in Financial Planning,” which he says are surprises, change and failure. And he says that the Roth IRA offers the liquidity you’ll need to deal with those three guarantees. “Roth IRAs are unlike any other retirement investment bucket, for lack of a better term, as you’re allowed to back money out of the account for any reason at any time at any age and without any tax consequences or penalties.” Since you pay taxes on your money before it goes into the Roth, you can withdraw your contributions whenever you need to, tax-free. (If you withdraw all of your contributions and begin dipping into earnings before the account has been open for at least five years, however, that money would be taxed and, if you’re under age 591/2, also hit with a penalty. There are exceptions — more on that in a minute.) Of course, we don’t recommend dipping into your retirement savings early for any frivolous reason. But in the case of an emergency, you’ll be glad to know your money is accessible.
Roth withdrawals in retirement are generally tax free, unlike payouts from traditional IRAs, which are generally taxed in your top tax bracket. This unique characteristic of Roth accounts is especially advantageous for young savers. When you’re just starting out, you can assume (or at least hope) that your income will go up and you’ll climb to a higher tax bracket in later years. So you’re better off paying taxes on contributions now rather than on withdrawals later.
You can withdraw all of your contributions and up to $10,000 of earnings to buy your first house, tax- and penalty-free, once the account has been opened for at least five years. Personal-finance blogger Kevin Mulligan writes at FreeFromBroke.com, “Because the Roth has its own special tax considerations (you contribute after you are taxed), it also has special withdrawal rules, which could be very beneficial to you.” After your account has been open for at least five years, you’re free to withdraw not only your contributions but also up to $10,000 of earnings income tax-free and without penalty at any age to buy your first home. Again, we wouldn’t recommend stealing these funds from your future self. But this kind of flexibility is certainly an appealing quality of the Roth.
Unlike a 401(k), Roth IRAs give you more flexibility to maximize your contributions to the account each year. While you’re still limited to $5,000 in annual Roth contributions, you get a 16-month window to fund the account. “Perfect for procrastinators like me, the Roth IRA account type allows people to contribute to their Roth IRA right up until tax day of the following year,” writes Anderson.
You’ll enjoy greater freedom of choice with a Roth IRA than with a company retirement plan. Anderson also notes that “a Roth IRA will usually have more investment options than your company 401(k),” for which your choices would be limited to the funds selected by your employer. You’ll be free to invest in stocks, bonds, certificates of deposit, mutual funds, exchange-traded funds and more, allowing you to create an appropriately diversified portfolio.
Leave your money to grow in a Roth your whole life long. With a 401(k) or traditional IRA, you’ll typically have to make annual required minimum distributions once you turn 701/2. Not so with a Roth IRA. “With my Roth IRA, I’m in control of when I make withdrawals,” writes blogger Britt Gillette at Your Roth IRA. “I’m not forced to do anything. In fact, if I want to let my money compound tax-free until I die at age 100, I can do so.”
Even when you’re gone, your Roth IRA will still be doing good. You can pass your account funds on after you die, and “heirs get to receive this money in annual or lump-sum distributions in the same tax-free way that you would have,” writes financial planner Francis St. Onge at All Things Financial Planning Blog. “By contrast, if they receive your 401(k) or IRA as an inheritance, they will have to pay taxes on the amount withdrawn each year, just like you did.”
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