How cool would it be if I told you that you won't have to worry about your retirement? Well, it's very true because, as someone with a lot of time before retirement, you have the ability to get a jump on things and get a head start towards saving for that Malibu beach home you'll be relaxing in your later years.
You can do this by taking advantage of something as simple as a Roth IRA. An IRA is short for "Individual Retirement Account," which is a retirement account that allows your money to grow tax-deferred until retirement. So rather than paying for taxes each year on your investments, you only pay taxes when you take the money out at retirement. Not only that, but the contributions you make to your IRA are tax deductible. So if you earned $40,000 one year and contributed $3,000 (the maximum contribution) to your IRA, you would only have to pay taxes on $37,000 of income. So it saves you on your tax bill too.
One unique form of an IRA that goes one step further is the Roth IRA. A Roth IRA is a form of IRA that you pay taxes on upfront. So if you contributed $3,000 to your Roth IRA and you are in the 30% tax bracket, $900 will be paid in taxes on this contribution. However, the nice thing about this is that the money grows tax-free until retirement (after age 59 ?).
You might be thinking, "Great?but why should I care now?" The reason you should care is because you can open a Roth IRA and take advantage of time and compounding to save towards your retirement. In fact, take this for an example:
You're 20 years old and in college with a work-study job. You can't save a whole lot of money because of your tuition payments but you manage to set aside $25/month into your Roth IRA that pays an average of 12% a year (the stock market has historically returned 12% per year). You're not making much money so you're in the 10% tax bracket while you're in college. After you graduate, you accept a job that puts you in the 27% tax bracket and you contribute $3,000 a year until you retire at the age of 65. Upon retirement, you will have contributed a total of $129,600 but you will have a hefty nestegg of $1,084,079 after taxes and inflation! You will be a millionaire.
A lot of people think they can just keep putting off saving for their retirement. But there are obvious advantages to opening up a Roth IRA while you are young or in college. Here are a few of the more notable advantages:
You have time on your side. The longer you keep your money invested, the more time it will have to compound, which means dramatically higher amounts of savings. Using the abovementioned example, had the student not began saving for their retirement until age 26, he would have only retired with about $806,000 - a difference of over $275,000?just by starting 4 years later! Imagined if you waited until you were 30 or 35 to start.
Roth IRA contributions are taxed at your current tax rate. Because students usually don't have high incomes, they'll likely just pay 10% in taxes. So even if you are in the 30% or 35% tax bracket when you retire, you will have only paid 10% in taxes.
The money can be used towards your first home. While Roth IRA's are best used for retirement, you can also withdraw money for the principal on your first home without paying taxes or penalties.
Roth IRA's are great investment vehicles for someone to take advantage of while they're young. But before opening one up, always be sure to consider the early withdrawal penalties before opening one up and stick to the mindset that this is a long-term investment vehicle and should only be used for retirement. But once you open on up, you can pretty much just sit back and relax with a little more security about your future.