Recently, I’ve conducted a poll on Instagram to see whether or not millennials a.) began investing in a Roth IRA or b.) have no clue what a Roth IRA is. And the results weren’t too shocking, but unfortunately the following:
I say unfortunately because people our age, who should be utilizing Roth IRAs, lack the knowledge of what a Roth IRA is, what it does, and how it works.
Roth IRAs make the most sense for young, lower-income workers (a.k.a millennials), which is why I decided to go over it in this week’s post!
WHAT IS A ROTH IRA?
A Roth Individual Retirement Account (IRA) is another type of retirement account, like your 401(K), that allows you to fund after taxed income into a brokerage account of your choosing.
Why shouldn’t I invest into a traditional IRA just like I did with my company’s traditional 401(K)? Let’s differentiate between the traditional IRA and Roth IRA:
- The biggest difference between the two is WHEN your income is taxed. Traditional IRAs are taxed upon withdrawal from retirement, while money put into a Roth IRA is already taxed from your pay.
- The Roth IRA has a yearly contribution limit of $5,500 (or $6,500 if you’re over the age of 50) per year for an averaged salaried employer making less than $120k per year claiming single or $189k per year filed jointly. The traditional IRA has ZERO contribution limits.
- A traditional IRA prevents you from making contributions into retirement after 70 ½ years of age and you must begin withdrawing money from your traditional IRA at this age also. A Roth IRA allows you to fund the retirement account forever, while never having to withdraw a single penny.
- Once you hit the phase out range (a yearly income of $120-130k for singles and $189-199k for joint couples), you can no longer contribute to a Roth IRA.
If your tax rate will be higher at retirement (meaning you’ll make more money by your retiring age), then a Roth IRA provides an option to save for retirement while utilizing tax-free compounded growth. If you’re in Levels 1-3 of the U.S. tax bracket (maximum yearly salary of $92,000 per year), then Roth IRAs make more sense for you.
The biggest benefit the Roth IRA provides is its flexibility. You can withdraw your contribution, minus its earnings from your Roth IRA anytime you want. This makes this type of retirement account ideal for saving money for large down payments or a child’s education.
If you do want to withdraw everything including your earnings, it’ll be a 10% penalty, or you can just wait until your 59 ½ years of age to withdraw all of your money penalty free.
WHY & WHEN TO START A ROTH IRA?
Like I’ve stated in my last personal finance related post, if you’re companies’ traditional 401(K) only offers high expense ratio investment options, don’t bother touching their 401(k). Start investing into your own Roth IRA instead.
But what to do if my company has a good 401(k) plan, and I contribute the maximum amount of money to get my company’s match?
Easy solution: open up a Roth IRA.
The reason most people start a Roth IRA instead of increasing their 401(K) contributions is because their investments (minus its earnings) are accessible penalty free in a Roth IRA. If you increase your contributions in your company’s 401(k) instead, that money isn’t touchable without paying a 10% penalty or waiting until you’re much older.
Also, Roth IRA investments with brokerage firms offer more, and usually better investment options than a company’s 401(K) plan. This can be good or bad, depending on how financially educated you are. Sometimes more choice equates to higher odds of bad investments (a kid in a candy store).
The reason I personally opened up a Roth IRA was a.) to allow my money to make myself more money, and b.) the benefits for first time home buyers. You can withdraw all of your contributions and up to $10k of your Roth IRA’s earnings to buy your first house penalty/tax-free if you’ve had a Roth IRA opened up for at least five years.
If you have children of your own, a Roth IRA is a great place to leave money for your heirs. Like I’ve said earlier, you can leave your money in your Roth IRA FOREVER. Children and grandchildren can then receive your smart financial decisions tax-free.
So, when NOT to open a Roth IRA?
- Your employer offers good investment options, but you haven’t matched their maximum amount of contributions. Match your employer’s 401(k) contributions to get that FREE money before opening a Roth IRA.
- If you haven’t paid off high interest credit card debts or have large student loans. TAKE CARE OF THIS FIRST!!!!
- On the rare occasion that a young person believes they will make less money in the future, start a traditional IRA instead.
WHAT AND WHERE TO INVEST IN?
As for as what brokerage firms to use, I personally am with Fidelity and have no complaints whatsoever. I chose Fidelity because my current employer uses Fidelity for their company’s 401(K) plan. Just made things easier for me to have all my investments with one broker. Some of the top recommended brokerage firms to start a Roth IRA are Schwab and Vanguard based on reviews I’ve seen online.
The absolute worst part about brokerage firms is that have “professionals” who offer help with your investments, but of course at a cost. This is NOT WORTH YOUR HARD EARNED MONEY. Spend a few weeks or months educating yourself and make your own smart financial decisions for FREE. Quit being lazy.
As far as what investments to go with, I’d stick with the basic S&P 500 index fund for starters, just like I’ve recommended in my traditional 401(K) post.
Hopefully you’re a tad more educated on Roth IRAs and understand why they are so important for us millennials. If you have any questions, don’t hesitate to reach out to me via email!
If you’ve missed last week’s post on “Four Life Hacks That Will Save You Bank”, click here! As always, don’t forget to like, comment, share, and subscribe.
“In the long run, it’s not just how much money you make that will determine your future prosperity. It’s how much of that money you put to work by saving it and investing it.”
Book of the Month: “Rich Dad Poor Dad” by Robert Kiyosaki