Millennial Roth IRA
If you’re a Millennial (or Post-Millennial), the one thing that might not be on your radar yet is retirement. After all, you have decades until you retire, if at all. As a young adult, it’s important to know the benefits of retirement accounts, specifically the Roth IRA. It goes without saying that the sooner you start saving for retirement, the better position you will be in as you get closer. You don’t want to wake up one day and realize you’re 50 years old and have little or nothing saved for your Golden Years.
The Roth IRA Backstory
An Individual Retirement Account, or IRA, is a retirement savings vehicle that you can utilize to put aside money for when you retire. Traditional plans offer an upfront tax deduction, however, all distributions from the account are taxable. The Roth IRA is named for Senator William Roth (R-Del) who, along with Senator Bob Packwood of Oregon, introduced the concept of the “IRA Plus”, which saw no immediate tax breaks, but allowed for tax-free distributions during retirement. The Taxpayer Relief Act of 1997 established the “Roth IRA”.
The Rules of the Roth IRA
To fund a Roth IRA, you must have earned income during the year(s) you wish to contribute. The amount you can contribute to an IRA (whether traditional or Roth) is set forth by the IRS. For 2018, you may contribute the lesser of your earned income from the year or $5,500. Note: if you are at least 50 years of age, you may contribute another $1,000 which is known as a “catch-up” contribution.
As stated above, you do not receive an immediate tax break for Roth IRA contributions. These accounts are funded with after-tax dollars. In contrast, traditional IRAs are funded with pre-tax dollars. To put it simply, traditional contributions occur before you get a paycheck, while Roth contributions come after your salary has been taxed and your paycheck received.
Lastly, Roth IRAs do not have any required minimum distributions. You can continue to contribute to one so long as you keep earning money.
Unlike traditional plans, Roth IRAs have income limits. You cannot directly contribute to a Roth if you make too much money. For 2018, those limits are as follows:
- Single Filers – If your earned income is over $135,000, you cannot make Roth IRA contributions (phaseouts start at $120,000)
- Married Filing Jointly – If your earned income is over $199,000, you cannot make Roth IRA contributions (phaseouts start at $189,000)
There are no longer any limitations about converting traditional funds to a Roth account. At any time and for any amount, you may choose to convert funds to a Roth IRA. The only caveat, is that you must pay taxes on the amount converted.
All qualified Roth IRA distributions are tax-free. For a distribution to be qualified, you must have had the Roth account for at least five (5) years and be at least age 59 1/2. Failure to meet this criterion will lead to penalties.
The Benefits of a Roth IRA
No 401(k)/Bad 401(k)
More employers are offering employees a 401(k) plan as an incentive to come work for them. However, not all businesses offer access to retirement plans. Further, factors such as investment options, fees and education may make an offered plan less desirable. Anyone with earned income can open and contribute to a Roth IRA. This is especially true for today’s “gig” worker who doesn’t work for one company.
Let’s face it, you’re not getting any younger, so let your age work for you. The earlier you start putting aside money for retirement, the more the power of compounding will benefit you. With a Roth IRA, that compounding will lead to a larger nest egg than saving with a traditional plan. (See Examples below)
Unless you landed your dream job and are rolling in the dough at 25, you probably haven’t even come close to your peak earnings potential. Most people will achieve their highest salaries later on in life. Would you rather get a tax break now, when you’ve just entered the workforce, or later on in life when you’re making the big bucks??
You may have read that you should have anywhere from three to six months’ salary put aside for an emergency. You may not know that a Roth IRA can be used for this purpose. Any contributions you make to a Roth can be withdrawn at any time and for any reason without being hit with a hefty tax bill or early withdrawal penalties. This is only true for contributions, not any earnings. For example, you contribute $10,000 and now your plan is worth $15,000, you may only withdraw the $10,000 contribution penalty-free.
Stretch it out
Since you never have to take distributions from your Roth IRA, it serves as a great estate planning tool. You may choose to pass on your tax-free IRA to your heirs. If your spouse is the beneficiary, he or she can assume it as his or her own and continue to contribute. If you leave it to a non-spouse (such as a child), he or she will be subject to minimum distributions, but they should remain tax-free.
Millennial Roth IRA – Examples
Sophia is 28 years old and makes a Roth IRA contribution of $4,500 every year until she reaches age 70. Let’s assume she is in the 30% tax bracket and earns 9.5% on her investments. When she retires at 70, her Roth IRA account would be worth $4,097,156. If Sophia had made these $4,500 contributions though a taxable account, the account would only be worth $1,408,347.
Jen is 23 years old and makes a $365 ($1/day) annual contribution to a Roth IRA until she reaches age 70. Let’s assume she is also in the 30% tax bracket and earns 7.5% on her investments. When she retires at 70, her Roth IRA account would be worth $151,385. If Jen had made these $365 contributions though a taxable account, the account would only be worth $73,740.
Josh is 25 years old and contributes $1,825 ($5/day) to his Roth IRA each year until he reaches age 70. Josh is in the 30% tax bracket as well and earns 8% on his investments. When he retires at 70, his Roth IRA account would be worth $761,803. If Josh had made these $1,095 contributions though a taxable account, the account would only be worth $365,176.
With so much education available online, it would be silly for Millennials and later generations to ignore retirement until it’s too late. In a world of TL;DR, it helps to take the time to educate oneself about all things finance. After all, don’t you want to actually enjoy your Golden Years instead of working through them?