When young professionals ask me how to get ahead financially, as a financial planning professional, I have a laundry list: create a budget, start investing now, be smart about taxes, and so on. If I had to narrow it down to one thing, I'd open up a Roth individual retirement account.
A Roth IRA is the investment account I love almost as much as a good 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.
Understanding the Basics of Roth IRA - Tax Benefits, Withdrawal Rules, and More
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.
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 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 of contribution. You pay taxes when you take the money out at retirement. 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.
For many reasons, a Roth IRA is the Millennials' and Gen Zers' ultimate investment account. I outline five:
- Withdrawals from a Roth IRA at retirement are generally tax-free. Because the money you put into a Roth IRA is after-tax money, the government doesn't tax you again on withdrawals.
- You can make contribution withdrawals at any time without penalty. This is a massive benefit for younger generations, who may expect significant expenses like a house down payment, education fees, and marriage. In addition, you can 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 simultaneously. When you participate in a 401(k) plan at work, the Internal Revenue Service limits your contributions 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. You can start contributing if you have income from a job, be it babysitting or mowing lawns. And the IRS doesn't care what money you actually use to contribute. Your parents can make a contribution for you.
- 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 age 72. On the contrary, you do not need to take money out at any age with a Roth IRA. The money can grow for your lifetime and be passed on to your future heirs.
Millennials and Gen Zers both have a significant advantage in time. Today's small contribution to a Roth IRA can grow into a nice tax-free nest egg.
Start investing in your future now.
