Americans have one of the lowest savings rates for developed countries. Americans are the ultimate consumers, and that definitely plays a role. However, I believe that education—or its lack thereof—is a big factor. Most people don’t understand the basic concepts of retirement planning and how crucial it is, largely because it’s not widely taught in our high schools or even our colleges and universities.
As the Rolling Stones song goes, “time is on your side,” so millennials listen up. The key to securing financial security when you are older so you don’t have to work your entire life is the Roth IRA.
Traditional and Roth IRAs allow you to save money for retirement. A Traditional IRA is a pre-tax retirement account that allow one to receive a tax deduction for the amount contributed, but distributions are subject to tax upon withdrawal, as well as an additional 10% percent penalty if the distribution is taken before the age of 59 1/2. Whereas, a Roth IRA is an after tax-account that does not offer a tax deduction for the contribution, but so long as the Roth IRA has been opened at least five years and the Roth IRA holder is at least 59 1/2 at the time of the distribution, no tax would be due. In addition, there is no requirement to take minimum distributions, as in the case of a pre-tax IRA. Hence, many retirement investors looking to secure tax-free retirement wealth generally turn to the Roth IRA.
When it comes to establishing an IRA, one must generally have earned income in order to be eligible to make a contribution. Earned income is generally defined as compensation for services, such as wages, salaries, commissions, and self-employment income. Passive income, such as capital gains, dividends, interest, and rental income is typically not considered earned income.
So if you are a millennial and have earned income, there is no excuse to to open a Roth IRA. Even saving just a few dollars a day will make a huge difference. For example, if you started funding a Roth IRA with just $4 a day or $1424 a year and continued through the age of seventy, assuming you were able to generate a 8% annual rate of return (the average rate of return for stocks was 12.23 percent from 1920 to 2017) you would wind up with $882,413 tax-free at retirement. Not a bad result for investing only a few dollars a day.
As someone in their forties, I wish someone gave me this information at a young age. I graduated from law school and have a master’s in taxation and not once was I ever taught about retirement accounts or their benefits. I must have taken hundreds of university and law courses, but no one ever explained to me the value of retirement savings or the power of the Roth IRA. How can we expect Americans, especially young Americans who are just starting out in their careers, to take advantage of retirement savings if they are not taught about the benefits? I have talked to tens of thousands of retirement-account holders and am always amazed how many people say, “I wish I had started saving for retirement earlier” or “I wish I had understood the benefits of a Roth account fifteen years ago.” While I am not the most sophisticated investor, I have a diverse tax and investment background, but I only learned about the benefits of using a Roth account to make investments through research I’d done for a client.
Anyone reading this blog now has the power to do something that can have a direct impact on their financial future and the future wealth of their family. You can open a Roth IRA account at any bank in a few minutes for free. You may think that retirement is a long way off so why care now, but that is the wrong attitude. In order to fully benefit from the power of the Roth IRA, one must be young and be consistent in making annual Roth IRA contributions. That is why it is so important that millennials listen up and get started making Roth IRA contributions. Trust the process and the process will bring you financial security and wealth.
Learning about the Roth IRA may end up being more financially rewarding than your college degree.