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How would you like to turn $20,000 of savings into $500,000 by the time you retire? Open a Roth IRA (individual retirement account), and watch your wealth multiply.
Typical college students are not focused on retirement savings. They have just stepped out from their parents’ nest and are enjoying their first taste of freedom. Even though they may not have much money, they have the most coveted possession of all retirement planners – time.
A Roth IRA is an excellent investment vehicle for college students for a variety of reasons. The primary argument for opening a Roth IRA is the expectation of being in a higher tax bracket in the future. College students who have summer jobs, work-studies or part-time positions are usually paying a fairly low tax rate because their income is not very substantial. However, taking a portion of your income to make small deposits into a Roth IRA can reap major savings in the long run.
The liquidity of the Roth IRA makes it one of the most valuable investment options for young adults. In case of an emergency, you would be able to withdraw your contributions immediately with no penalties.
Tim Maurer, CEO of Financial Consulate, says “Roth IRAs are unlike any other retirement investment bucket, for lack of a better term, as you’re allowed to back money out of the account for any reason at any time at any age and without any tax consequences or penalties.”’
For example, let’s say you deposit $5,000 each year of college into a Roth IRA. Over four years, the total contributions will be $20,000. Assuming that your investments have an average growth rate of 7.5 percent each year until you are 65, you will have accumulated over $530,000 in your Roth IRA – all tax-free! If your investments grew at an annual rate of 8.5%, then your IRA account would be worth over $820,000 by the time you are 65.
Unlike Traditional IRAs or company 401(k) plans, the Roth IRA is funded through taxed income. Even though you will not receive the upfront tax break that traditional retirement plans offer, you will not have to pay any type of taxes on withdrawals from the Roth IRA because most withdrawals from a Roth IRA are tax-free.
After you’ve opened up a Roth IRA for 5 years, you now have the availability of withdrawing up to $10,000 of earnings from the account to buy your first house tax and penalty free. This unique characteristic of the Roth IRA is an excellent incentive for students to begin saving money towards the beginning of a brand new life after graduation.
Once you turn 59 1/2 years old, you are now allowed to withdraw the earnings portion of the Roth IRA, but without having to adhere to required minimum distributions or withdrawals as with Traditional IRAs or 401(k) plans. You have complete control over the account. Also, a Roth IRA allows you to continue to make contributions to the account forever, unlike the traditional accounts that do not allow contributions past the age of 70 1/2. These characteristics are particularly valuable for estate planning purposes, as the account has the potential to keep growing until death. This also allows heirs to inherit a Roth IRA and not be subject to any income tax on that money.
Opening a Roth IRA is fairly simple. Choosing the right financial institution is the hard part. My advice is to look at the “Big Three” – Fidelity Investments, The Vanguard Group and T. Rowe Price. They offer numerous types of retirement accounts that will suit your investment needs and styles.
Once your account is open, I suggest avoiding single stock purchases for your portfolio. Instead, as recommended by countless financial advisers, buy low-cost, diversified mutual funds or index funds. This is the best way to embrace the “get rich slowly” ideology and a smart way to own a piece of the market while mitigating risk.
For college students, Roth IRA funding offers an incredible opportunity to benefit from decades of tax-free, compounded growth. Don’t let this one pass you by.
