Why Roth IRAs Are the Perfect Retirement Tool for New Grads

Kat Tretina

September 11, 2017  •  3 Minute Read

Banking & Investing

When you have student loans, rent and an entry-level salary, saving for retirement is probably the last thing on your mind. However, it’s important for your future. Studies have found again and again that Americans are unprepared for retirement. That means it’s likely that many could be in desperate straits when they are older. Starting to save now, when you’re young and time is on your side, can ensure you’re comfortable throughout your lifetime.

If your employer offers you a 401(k) and will match your contributions, it’s smart to take full advantage of that benefit — it’s basically free money. But if your employer doesn’t offer a 401(k), a Roth IRA can be the best option for young savers.

What is a Roth IRA?

A Roth IRA is a retirement savings account that works differently from 401(k) plans. You contribute your pre-tax dollars to your 401(k). But with a Roth IRA, you contribute post-tax dollars. Roth IRAs don’t offer upfront tax benefits, but you contribute money that you paid taxes on already. That might not sound that exciting, but it’s a big deal.

If you have a 401(k), the IRS will tax your account withdrawals as income when you’re in retirement. But with a Roth, you can withdrawal your money tax-free, because you paid taxes when you first invested. That also means that any gains your account earned are tax-free, as well.

Roths are Awesome When You’re Starting Out

While Roth IRAs are excellent retirement plans for all ages, they can be especially useful for millennials and people just starting out.

Finding the money to save for retirement and build an emergency fund on a small salary can feel impossible. Investing in a Roth IRA can help relieve some of that burden.

If you run into an emergency, such as your car breaks down or you have unexpected medical bills, you can use portions of your Roth IRA to manage the expense without paying tons of fees,

With a 401(K), if you withdrawal money from your account before retirement age, you will be hit with income taxes and a penalty. Those costs can eat up a significant chunk of your nest egg. But with a Roth, you can take out the money you invested without paying taxes or penalties.

The one catch is you can only withdraw what you invested, not what the account gained. For example, if you invested $10,000, and your Roth grew to $12,000 thanks to your investment earnings, you could only withdraw the original $10,000. If you wanted to take out the full $12,000, you would be subject to early withdraw penalties.

Eligibility

As of 2017, you can invest up to $5,500 a year into your new account. Once you are 50 or older, you can make extra contributions and invest up to $6,500 a year.

Not everyone is eligible for a Roth IRA. There are a few income restrictions:

• If you are single and make under $118,000, you can invest up to the full amount — $5,500.
• If you are married and your combined income is less than $186,000, you can invest up to the full amount as well.

If your income exceeds those accounts, you might still be able to contribute a reduced amount. However, if your income is too high, you might not be able to contribute to a Roth IRA at all.

How to Open a Roth IRA

Most banks, including brick and mortar branches and online versions, offer Roth IRAs, You can open an account with banks like USAA or CapitalOne. Or, you can invest through a brokerage firm like Vanguard, Fidelity or T. Rowe Price.

Some banks require you to invest at least $500 or $1,000 to start, but others will allow you to open an account with as little as $25. If you don’t have much money saved just yet, it’s a good idea to compare different banks. Alternatively, you can start saving a little money each month into a savings account and invest it once you reach the bank’s minimum.

Once you open an account, you can select your investments. If you’re overwhelmed by the options, you might want to look into investments based on your target retirement date. Those funds are a mix of stocks, bonds and cash that change based on your age and your comfort level with risk.

Start Saving

While building your nest egg might not be on your priority list right now, starting early can help you in the long run. By investing just $25 a month or whatever you can afford now, you can establish a strong retirement fund to see you through your golden years.