By now, we’re sure you’ve heard about all the advantages of saving and investing with an individual retirement account, or IRA, even if your “golden years” are decades away. But have you heard about the Roth IRA, a vehicle that could boost your savings even more? Did you know that it could be a great solution for Millennials?
If the Roth IRA is totally new to you, here’s a quick rundown.
Roth or Traditional IRAs?
Roth IRAs have a big difference from traditional IRAs: The money you sock away into a Roth IRA grows on a tax-free basis, and you can withdraw those funds free of income tax considerations no matter how old you are. And once you hit age 59½ (or meet specific criteria — see below), you can withdraw any interest, dividends or capital gains that the account accrues tax free too. Traditional IRA withdrawals are taxed as regular income.
Now, with a traditional IRA, you can take tax deductions on the contributions that you make every year. This saves you taxes now. But on the flip side, Roth IRAs can save you a boatload in taxes when it’s time to withdraw. And for 2018, you can take deductions on a traditional IRA only if you make less than $63,000 (for a single person) or $101,000 (if married and filing jointly). So if you make more than that per year, clearly a Roth IRA makes more sense.
Here’s another advantage that Roth IRAs have over their traditional counterparts: Roth IRAs involve no required minimum distributions (RMDs) once you hit age 70 ½ . That means that you can keep building your investment for literally the rest of your life. You don’t ever have to worry about outliving your money.
You can read more about the differences between Roth and traditional IRAs here.
Why Roth IRAs Are Great for Millennials
OK, so why do we urge Millennials in particular to start saving with Roth IRAs now?
The answer is a bit of a no-brainer: The sooner you start saving for retirement, the larger the nest egg you should have when that day comes. That’s because of the magic of compound interest.
And due to its special tax treatment, your Roth withdrawal at retirement will be larger than with a traditional IRA. You could withdraw all of that money without paying a dime in taxes. So a dollar put into a Roth IRA will be worth more than one investing in a traditional account.
There’s another big advantage that young people have with Roth IRAs. Remember we said above that you can withdraw interest, dividends or capital gains if you meet specific criteria?
Well, one of these criteria is a first-time home purchase. So if you’re in your 20s or 30s and looking to buy your first primary residence, you can take up to $10,000 from your Roth IRA earnings tax free.
Roth IRA or Pay Student Loans?
“Wait a minute!” you say. “What about my student loans?” If you are like many Millennials and still dealing with education debt, you might think that investing in a Roth IRA is something you should hold off on. Better to pay off the loans first, right?
Well, not necessarily. And we’re not just saying that because our name is Investor Junkie.
We believe that there are two kinds of debt: good debt and bad debt.
Good debt meets these rules of thumb:
- It’s a long-term loan of 10 years or more
- You can use the debt as a hedge against inflation
- The interest rate is fixed, as opposed to adjustable, revolving or balloon payment
- The interest rate on your debt is lower than the return you can see from investing
Guess what? While credit cards fail these tests, in many cases, student loans get a “pass” here — especially on the last criterion. The interest rate you’re paying on your student debt is probably going to be lower than the returns you’ll see from investing in a Roth IRA. So there’s no reason to wait until you pay off those college loans to get started with a retirement account today.
What About My 401(k)?
Here’s an important thing to note: It’s not really a question of whether you should choose a Roth IRA or a 401(k). Ideally, you should have both. But before you sign up for a Roth IRA, make sure you’re getting the most out of any employer-sponsored retirement plan.
If it doesn’t suck, take advantage of any contribution matching your company will do (free money — yay!) and then get started with a Roth IRA as soon as you can. Use both accounts to ramp up your saving power!
If your 401(k) does suck, consider rolling it into an IRA. (Note: If you choose to roll over a 401(k) into a Roth IRA, you will have to pay taxes now on the amount. But if you can afford the tax bill, we think it’s worth it.)
So How Do You Get Started?
So now that we’ve got you convinced, how do you get started with this great savings tool whether you’re 20… 25… 30… or, really, any age?
But whatever platform you choose for opening a Roth IRA, here are some things to look for:
- No or low account fees
- Low account minimums
- Commission-free exchange-traded funds (ETFs)
- Retirement tools to make planning easier
In addition, some platforms are offering promotions and specials for opening up new Roth accounts. Here’s a link to the best current IRA promotions.
Do you have a Roth IRA? What do you think about this savings tool?