If Millennials or Generation Zers ask me what to do to get ahead financially, I have a laundry list: create a budget, start investing now, be smart about your taxes and so on. If I absolutely have to narrow it down to one thing, I‘d say open up a Roth individual retirement account.
A Roth IRA is the investment account I love almost as much as a good California burrito. Most younger folks don’t know what types of retirement accounts to start with. If your employer offers a 401(k) plan, go for it. This is especially true if your employer matches your contributions – it’s free money. But you can and should still own a Roth IRA.
Make Savings Automatic
Before I get into the Roth IRA love fest, let’s talk about some basic history and what this vehicle actually is. The Taxpayer Relief Act of 1997 created the Roth IRA. The man who helped push the concept through legislation was Senator William Roth – hence the name Roth IRA. Pretty cool to have a retirement account named after you, in my opinion.
A Roth IRA is, as the name implies, an account an individual opens to save for retirement. In most circumstances, you cannot take out the earnings until you reach 59½ without incurring a penalty.
A Roth IRA is similar to a traditional IRA, but one main difference is the tax benefits. With a traditional IRA, you typically get a tax deduction in the tax year you make a contribution. When you take the money out at retirement, you pay taxes on those withdrawals. With a Roth IRA, you do not receive an upfront tax deduction for your contributions, meaning you pay your tax now, but when you take money out after 59½, the withdrawals are tax-free.
A Roth IRA is the Millennials and Gen Zers’ ultimate investment account for many reasons. I outline seven:
- The money you take out of your Roth IRA at retirement is generally tax-free. Because the money you put into a Roth IRA is after-tax money, and you don’t get a tax deduction like you would with a traditional IRA, the government doesn’t tax you again on withdrawals. If you start a Roth IRA account today at 25, and contribute $5,000 every year into the account until 65, at a 7% rate of return, you have about a million tax-free bucks at retirement. Not too shabby. (This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.)
- You can withdraw the contributions you make at any time, without penalty. This is a huge benefit for younger generations, who may expect large expenses like a house down payment, education fees and marriage. In addition, you are able to take out earnings for your first home purchase if you meet all the rules. However, early withdrawal is a last resort as it diminishes the growth that compounds over time.
- You can contribute to a 401(k) and a Roth IRA at the same time. When you participate in a 401(k) plan at work, the Internal Revenue Service limits the contributions you are able to make to a traditional IRA. This is not the case with a Roth IRA. As long as you are under the income phase-out limits (currently $129,000 if you’re single, and $204,000 if you’re married), you can contribute the maximum $6,000 to your Roth IRA each year, in addition to contributing to your 401(k) account.
- You can open a Roth IRA at any age as soon as you have earned income. As long as you have income from a job, be it babysitting or mowing lawns, you can start contributing. And the IRS doesn’t care what money you actually use to contribute. Your parents can make the contribution for you.
- You can keep contributing even after you retire. With a traditional IRA, you typically cannot make contributions after you are 70½. With a Roth IRA, you can make contributions no matter how old you are – even on your 100th birthday.
- Your money can keep growing after you retire. Most tax deferred retirement accounts, such as 401(k)s and traditional IRAs, require you to start taking money out after 70½. On the contrary, with a Roth IRA, you do not need to take money out at any age. The money can grow for your lifetime and be passed on to your future heirs.
- You have four more months to make a contribution. For your 401(k), you generally have one calendar year (Jan. 1 through Dec. 31) to make your contributions. For your Roth IRA, you have up until the tax day, April 15th, to contribute. This gives you a good amount of flexibility. But the sooner you make your contributions, the sooner the money starts to compound and works for you.
Millennials and Gen Zers both have a great advantage in time. A small contribution today to a Roth IRA can grow to a nice tax-free nest egg.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
This article was prepared by FMeX.
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