Saturday, August 6, 2011

Why everyone my age should open a Roth IRA

A few months ago I visited a friend in New York who told me he didn’t see any reason to be saving for retirement at such a young age. I think this attitude is not uncommon among my peers—after college, life gets expensive. We’re now paying for rent, for groceries, outings and alcohol, cars and insurance, medical co-pays or monthly premiums, furniture, utilities, public transportation, wardrobes, travel, and saving for the near future. It makes so much sense to want liquid savings, aka money that’s easily accessible, such as a savings or checking account, perhaps a Money Market Account or a CD (for some hold up your money for as little as six months to a year). To recap: living is expensive, and we want our savings within reach. So many short-term expenses can come up: travel, equipment, appliances, moving costs, education, and a down payment on a house or deposit on a rental property.

I personally intend to take advantage of my 401(k), 529, AND Roth IRA, but I will focus on the last one for this post, as I feel it’s the most important for people my age to know about. Firstly, an IRA is a savings account for retirement, and there are several types, most notably a traditional and a Roth. With a traditional IRA, you put pre-tax dollars into the account, and pay taxes on all the money when you take it out. With a Roth, you put in money that you have paid taxes for, but then do not pay any taxes when taking the money out, INCLUDING no taxes on the money you have earned through compound growth. For us young people, a Roth makes a lot of sense because our income will grow over the course of our lifetime, so we will be paying a lower tax rate when putting in the money than we would be when we take it out. Additionally, our money will be in the account for a lifetime, so we will earn a lot of interest—and not have to pay taxes on it!

An important rule about the IRA is that you may put in a maximum of 5K per year (with a slightly larger allowance for those who are old and closer to retirement). One thing that I cannot stress enough is that there is a huge difference in how much interest you will earn if you wait ten years instead of starting now. There are many online calculators (such as on CNN Money) that can illuminate this difference. And I’m not talking about a difference of 100 thousand, but something much bigger—doubling your savings. Starting to save for retirement when you are young is such an opportunity—if you start early, you will end up having to contribute a lot less than if you wait to start, in order to end up with the same amount. I’ll keep you guys updated on my selection of an IRA, and how I will be allocating my assets. In the meantime, I urge you to take advantage of being young! Even saving 100/month will net over 1K per year, and put you on a great start!


  1. The problem is: many of us will not make it to retirement. Another issue - what will happen to the worth of the dollar, economy, and everything else in 40 yrs. time. I would go with shorter term investments, instead of waiting an uncertain eternity to get a return from the government)

  2. Hello ... (I can't figure out who you are)!

    You're right, not everyone lives to retirement age, but you can easily set up your Roth so that your money goes to your spouse, child, or preferred charity if you die before you deplete it. In the case that you don't end up being a healthy & active old person, medical care is expensive so the Roth would be of great help. As for shorter investments-- be careful that your money is appreciating at a rate that beats inflation! With rates for CDs and MMAs as low as they currently are, it's definitely something to consider as a negative for short-term investments. Thanks for reading!

  3. For those who can afford to save now definitely would be far better in the long run to do so. Even if the dollar does go all out of whack between now and then. We haven't experienced long-term deflation (recent peak was in July 2009 at just over 2% and lasted only a few months) since the great depression and the government is working to keep it that way. As long as the dollar is inflating, it is always better to invest that to sit on the money. I look forward to hearing more about your investigation into Roth IRAs as well as other options.

  4. Totally agree with you.

    “The most powerful force in the universe is compound interest” - Albert Einstein.