Roth IRAs Are Great Options for Young Professionals

Roth IRAs Are Great Options for Young ProfessionalsSaving for retirement may seem like a low priority if you are in your 20s. The pressures to pay off your student loans and save for a house seem more urgent. But the benefit of compounding interest is on your side and there is one financial product that stands above the rest – the Roth IRA. The benefits are so significant that every young person should take advantage and work hard to fully contribute each year.

The Benefits of a Roth IRA

A Roth IRA allows you to set aside money after taxes. You can contribute up to $5,500 in a Roth for 2015 if you are a single filer making less than $116,000 per year or a married couple making less than $183,000 per year. There are many great benefits to a Roth.

Tax-free income in retirement – Let’s start with the biggest benefit first. As noted earlier, people contribute to a Roth after taxes. The benefit to the saver is that he or she gets to draw the contributions and earnings tax free starting at age 59 ½. This fact means you get a tax free income stream in your retirement. If you contribute $5,500 annually (and the maximum contribution will increase from age 27 to age 67 (full retirement age for Social Security for anyone born in 1960 or later), your $220,000 in contributions is now worth over $1 million dollars. You are now a millionaire even before you count home equity, 401(k), or other assets. This scenario even assumes a very high marginal tax rate.

Withdraw contributions tax free – You might find yourself in a severe financial pinch at some point in the future. Unlike other savings vehicles, you can withdraw contributions (but not earnings) tax free. The after tax nature of Roth contributions means that you already met your tax obligations. Be aware that if you withdraw earnings you will face tax penalties.

Flexibility – You pick from an array of investments that are best for you, whether that’s stocks, bonds, real estate, or something else. You can still (and should!) participate in other retirement accounts such as a 401(k) and traditional IRA too. Just keep in mind your IRA contributions (Roth and traditional) cannot exceed $5,500 in 2015.

Other People Can Contribute to Your Roth – Generally, a person needs to have taxable compensation in order to fund a Roth IRA. There is an important exception. A spouse with taxable compensation can contribute to the Roth of the spouse with no taxable compensation. For instance, someone who makes $70,000 in a year can contribute up to $5,500 to the Roth of his stay-at-home mom.

If you are single, there is a way for relatives to contribute to your Roth. The key rule here is that a contribution cannot exceed a person’s taxable income. This statement means that if you are a college student making $4,000 a year in taxable compensation from summer and part-time employment, a parent or grandparent, per the IRS website, can contribute up to $4,000 to your Roth.

An All-Around Great Deal

A Roth IRA is a great way to build a retirement nest egg. It really rewards people who plan ahead and diligently save for retirement. You get the benefit of a tax free pool of money to finance your retirement expenses. Start saving today, saving in your 20s is way easier than saving later in life!

Other Roth Options

The Roth IRA is definitely the first-stop for retirement contributions for young people, but not the only place you can get the Roth advantages. There are Roth versions of 401(k), 403(b) and 457(b) plans, so if you are offered one of these by your employer, you should consider taking advantage! They’re not quite as flexible as the Roth IRA, but they do provide a great tax benefit if you’re in a low tax bracket.

3 Responses to Roth IRAs Are Great Options for Young Professionals

  1. I’ve only contributed to Roth IRAs to this point in my life. The biggest benefit of an IRA for me is that you don’t need an employer to provide the plan to you! I’ve never had a workplace-based retirement account so the IRA has been the only way to go (when I have had earned income).

  2. Jim Dasher says:

    Daniel,

    After reading the ROTH information on the IRS’ website, I cam up with an interesting question.

    For instance, if I read the IRS website information correctly, with a Roth 401(K), the individual’s contributions can be withdrawn tax free at retirement, but only on individual’s contributed portions, but not tax free, on their employer’s matching contributions. 

    Here’s my question, for any tax experts out there. Does the IRS offer any way for an individual, investing in a 401(k) program, the ability to “pre-pay” the taxes on their employer’s contributions to their 401(k) plan? If this were a possibility, it could potentially exempt the individual from having to pay any future taxes, when withdrawing moneys, upon their retirement. 

    It would be very interesting to find out if there is any options, in IRS tax code, that would allow for this type of 401(k) tax pre-payment.

    Thank You,
    Jim Dasher

    • Employers can only make 401(k) contributions, not Roth 401(k) contributions. But when you leave a job, you can roll that over to an IRA. From there, you could convert it to a Roth IRA. But if that’s a large sum of money, probably not worth it for a one-time tax burden.

      Another issue I’m thinking about is vesting. How can you prepay taxes if you don’t know how much the burden will be. What would happen if you vested 20% each year? Interesting question!

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