Saving 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.