This post is part of the Roth IRA Account Movement happening all across the personal finance blogosphere today. Never fear - the post is still written by me and it’s not an advertisement or anything. Just a well-timed post that I’ve been planning to write anyway.
So, retirement. Are you ready for it? Scared of it? Pretending it’s nothing to worry about? For a long time, I was an avoider - I was in my early 20s, fresh out of graduate school, and the LAST thing on my mind was how I’d pay for things when I got old. I mean, sure, I signed up for a 401(k) at my first job, but I ended up cashing it out when I left the company. Same thing happened at my second job.
In late 2010 when I decided to stop being an idiot, I knew I needed to come up with a solution for my retirement problems. First, I needed an account that could stay with me no matter where I worked. (Don’t judge me - job hopping is very common among my age group AND in my career field.) Second, I needed something I understood - all the company-sponsored retirement plans were run by dowdy old people who looked like they were just waiting for me to sign up so they could retire. They weren’t the least bit interested in explaining how things worked.
Enter the Roth IRA - the best way (in my opinion) to save for retirement.
What’s a Roth IRA?
An Individual Retirement Account (IRA) is a self-directed retirement savings plan for people who earn some type of income, whether that’s from self-employment or from an employer. In other words, IRAs are accounts you can open on your own to save for retirement.
There are two types of IRAs - traditional and Roth. I won’t spend an hour describing them because you can read that elsewhere (preferably from a CPA or other finance professional, which I am not). Basically, you contribute to a traditional IRA before taxes, or to a Roth IRA after taxes.
Why is a Roth IRA Better?
There are a number of reasons I prefer a Roth IRA to any other retirement account.
First of all, I like the fact that I can put money into my Roth no matter where I work. No transferring or closing old accounts, no complications, just money I’ve saved for retirement. Even if I move across the country, I don’t have to make any changes except my address.
Second, there are about a million places to open a Roth IRA. I could go to my bank or a local investment firm. Since we all know I’ve had bad experiences with traditional financial institutions in the past, though, I opted for an online brokerage.
Another great thing about the Roth IRA is the simplicity. I won’t lie - I know nothing about investing. When I signed up for my account with ShareBuilder, I answered some simple questions about my retirement goals, then I got to choose between a few different plans. If I ever actually sit down and figure out what the hell I’m doing, I can change my plan anytime I want - from one of the package deals with a cute name like “Elderly in 2050 FTW” to choosing the individual companies or funds where my money is invested.
Um, What About This “After Tax” Thing?
Isn’t it better to contribute to a retirement plan before taxes? Not necessarily. If you put pretax dollars into a traditional IRA, you’ll have to pay taxes when you withdraw the money later. If you’re in a higher tax bracket when you retire, you could end up paying quite a bit of money in taxes. With a Roth IRA, you pay taxes now, but your withdrawals in old age are tax-free.
If you’re making a crapload of money right now, the Roth may not be your best bet. For those who expect to be in a lower tax bracket in retirement, a traditional IRA may be a smart choice. But for people who, like me, expect to see their annual income increase quite a bit between now and retirement, the Roth is awesome.
I hate math, so I won’t bore you with a chart that shows the difference in potential earnings between a Roth and traditional IRA. But you can look at this handy calculator from ING to see how much more you could have in your golden years if you opt for the Roth IRA now (be sure to adjust the tax rates to reflect your situation).
What Else Do I Need to Know About Roth IRAs?
- If you’re under age 50, the most you can contribute to a Roth IRA is $5,000 per year ($6,000 per year if you’re over 50), and only if your income is below $105,000 (or $169,000 for married couples).
- You ARE able to withdraw the money you contribute to a Roth IRA without a penalty if you need to (but not the earnings). So if you put in $1000 and your balance grows to $1500 with interest, you can only take out the $1000 you actually put in without a penalty.
- Early withdrawals do have to be reported when you file your tax return. This could result in tax implications that I’m not qualified to explain - consult a tax professional.
- Before you open ANY type of retirement account, be sure you understand all your options. If your employer offers a 401(k) match, for instance, you’d be silly not to take advantage of the free money. But that doesn’t mean you couldn’t open a Roth or traditional IRA for savings beyond what it takes to get the company match.
The Bottom Line
For me, the Roth IRA has been a great way to save money for retirement. Even with all my job turmoil in 2011, I managed to save $2200, which is more than I’ve ever had before. As an added bonus, I didn’t feel dumb when I signed up for my IRA, even though I’m not savvy when it comes to investing.
Time is the most important factor when it comes to saving for retirement. The sooner you start saving, even if it’s only $20 a month, the better off you’ll be. If I had invested $1000 in a Roth when I got my first job at 22, that account would be worth around $1700 right now at age 29. Without saving another dime beyond that first $1000, I would have a balance near $27,000 at age 65, simply because of all the years the money would have to grow.
We may not like to think about getting old (I know I don’t!), but there aren’t any good ways around it. Whether you choose a Roth IRA or another type of retirement account, I urge you to start planning and saving TODAY. Don’t waste time regretting the years you may have missed - get started now so you never have to miss out again.
Andrea-
Great post and sage advice. With the way the markets have been for the last 10 years, however, your $1000 probably would have still been worth $1000 now. That is if you were buying funds with the money. If you were buying individual stocks and were good at it (like buying Apple or AFLAC), you’d have several thousand now. You could have also turned it into $100 if you had bought GE or Freddie Mac.
At retirement, your estimate is a bit low, assuming you can get 12%, which has been the market long-term average (which you may have been assuming a lower rate). At 12%, your original $1000 would be worth about $64,000 at 64 or $128,000 at 71. That goes for each $1000 invested, so if you stared with $10,000 you would have $640,000 at 64 and $1.28 million at retirement.
Too….much….math… Head….pounding… =P
I used a calculator that assumed 8% in both cases. Just trying to make a point, though I do appreciate the fine-tuned numbers. More proof that one doesn’t have to be a math or investing person to use a Roth!
Actually looking back, I screwed up the math. I was just using the rule of 72, which says you divide 72 by the interest rate, and that will give you the number of years until the amount you invested doubled. I was assuming 7 years to double, which is like 72/10, so the amounts I gave were for a 10% return. So at 10%, it would double about every 7 years.
At 12%, which is the long term average for the stock market, it would double every 6 years. So if you invest at 20, it would double at 26, 32, 38, 44, 50, 56, 62, and 68, or 8 times. So you would have 1, 2, 4, 8, 16, 32, 64, 128, 256 times your original investment. This means your $1000 invested at 20 would be worth a cool quarter million dollars at retirement.
This means that if you invest your first year’s state college tuition of $4000 instead of going to a state school, and flip burgers all your life and never invest another cent, you will retire a millionaire. Gotta love it when interest is on your side. Also gotta wonder if college is worth the price.
I couldn’t agree with you more about the benefits of a Roth IRA - and if you make more than $105,000 a year you can do a Roth IRA conversion. Although I believe in putting money into a 401k or any other company matching retirement account, I still believe Roth’s are one of the best ways to save money!
Ugh this just reminds me that I was irresponsible with the 401k from my old job. I missed the deadline to move it to a place of my choosing and now it’s moving to wherever my former employer is taking it. Damn procrastination. I need to convert it to an IRA, not a Roth though, tax penalties are not ok.
And more on the 401k note, some work plans are totally bogus with their 5 investment choices. **Shaking fist at current plan of suckiness**
Great to see you as part of the movement. If only they’d up the limit… I would work a second and third job just to “max the crap out of it.”
I’m not going to lie. I don’t have an IRA or a Roth IRA. Both are on my to-do list. I have been reading and learning about both, but honestly, until I get out of debt, I don’t have the extra money to put into either. I have a state job and I contribute 6.5% to retirement, while they contribute 14.2%. I know that I don’t need to count on that for my entire source of income upon retirement, but honestly, it’s the best I can do right now.
I have a Roth IRA and even if I can only contribute a measly sum to it while I’m in school, I made it a point to set up monthly contributions so at least I was doing *something,* since it’s so easy to feel disempowered when you’re broke, and equally easy to procrastinate!
Any progress is good progress in my book!
I think you might be incorrect on the limits. I believe you can contribute $6000 per year if you’re over 50, one of the few happy facts I learned last year when I crossed that threshhold.
Thanks for catching my error - correcting the post now.
God, I’ve been aware of the power of compounding interest since my early 20′s, but I dragged my feet on investing in an IRA, and now I really need to start.
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