Tuesday, July 14, 2015

10 Reasons everyone in their 20's needs to start a Roth IRA

Three years ago, I had a call from a dear, family friend. This man has been like another father to me for years, so when he calls I know it is important. As we spoke, he began to ask me some questions. 

"Claire, did your parents teach you about drugs growing up?" 


"Did they teach you about the importance of an education?"


"Did they teach you about sex?"


"Did they teach you about finances and how to invest in your future?"

Long pause. "I don't recall learning anything about investments or retirement and really I have a lot of questions about both of those things and don't even know where to start."

"Well, that is what I am going to teach you. Let's start with a Roth IRA. It is a no-brainer for a person in their 20's."

This is where my journey in learning how to invest our money began. Let's start where I did, with the Roth IRA.

What is a Roth IRA?
A Roth IRA is an individual retirement account that offers a valuable future tax break: Tax-free income in retirement. Like beauty, the benefit of a Roth IRA is in the eye of the beholder and it all depends on the beholder’s tax bracket--both now and when he or she retires.
Although there is no up-front tax deduction for Roth IRA contributions as there is with a traditional IRA, Roth distributions are tax-free when you follow the rules. And because every penny you stash in a Roth IRA is your money—not a tax-subsidized gift from Uncle Sam—you can tap your contributions (but not your earnings) any time tax-free and penalty-free.
Roth IRAs make the most sense if you expect your tax rate to be higher during retirement than your current rate. That makes Roth IRAs ideal savings vehicles for young, lower-income workers who won’t miss the upfront tax deduction and who will benefit from decades of tax-free, compounded growth. Roth IRAs also appeal to anyone who wants to minimize their tax bite in retirement as well as older, wealthier taxpayers who want to leave assets to their heirs tax-free.
You can contribute to a Roth IRA at any age as long as you have earned income from a job. www.rothira.com

Are you eligible? 
First things first. There are income eligibility limits, so if you make too much money, you can’t contribute to a Roth IRA. But with a median household income of about $50,000, most Americans qualify for Roth IRA contributions. (If your income is too high, you can convert some or all of the assets in your traditional IRA to a Roth IRA, but you’ll have to pay taxes on the entire amount you convert. For details, see more on Roth IRA conversions).
For 2014, you could contribute the maximum $5,500 to a Roth IRA ($6,500 if you are age 50 or older by the end of the year) if you are single or the single head of a household and your modified adjusted gross income (MAGI) is less than $114,000. Or, if you are married filing jointly, you can contribute the maximum amount to a Roth IRA if your income is less than $181,000. You may make a partial contribution to a Roth IRA if you are single and your income is between $114,000 and $129,000 or if you are married filing jointly and your income is between $181,000 and $191,000. You can’t contribute to a Roth IRA if your income is above those levels. (Special rules apply to married couples who live together at any time during the year but who file separate tax returns. Neither can contribute to a Roth IRA if their income exceeds $10,000.) www.rothira.com

Why does my retirement matter now? I am only in my 20's!
It's easy to understand why retirement doesn't loom large on the horizon for 20-somethings. Young workers are more concerned with kick-starting careers, not ending them in the long-distant future. Consider this scenario: If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you'll have around $560,000, assuming earnings grow at 8 percent annually. Now, let's say you wait until you're 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8 percent a year. When you're 65 you'll wind up with around $245,000 -- less than half the money.But it's worth noting that the very fact that you're young gives you a huge edge if you want to be rich in retirement. That's because when you're in your 20s, you can invest relatively little for a short period and wind up with far more money than someone older who saves much more over a longer period. Save a little now and reap big rewards later. Bankrate

10 Reasons why you should start a Roth IRA

  1. Tax Free- If you follow the rules, all the money you put into your Roth IRA during your working life will grow absolutely tax free upon retirement. In other words, you pay your taxes upfront when you are in a lower tax bracket and when you have let your investment grow then you don't have to pay taxes on it when you retire and could possibly be in a higher tax bracket. You can take tax-free distributions upon retirement and totally avoid paying taxes on the investment growth of your Roth IRA. You can cash-out when you are ready to retire and you can invest it in mutual funds, stocks, bonds, or real estate while your money is growing. It is more flexible than a traditional 401K retirement plan.This is also known as tax diversification. You will not be penalized if you wait to cash-out your investment until age 59.5. This is all in contrast to a traditional Roth or a 401K where you will owe income tax with each withdrawal you make on those investments. 
  2. More Money for RetirementFor those just starting out, the power of this tax shelter may seem a tad obscure, but it can really pay off big. If a 25-year-old contributes $5,000 each year until she retires and makes an average annual return of 8% on her investment, she'll have $1.4 million saved by the time she retires at age 65. And the money is all hers — she won't have to give the IRS a cent of it if she waits until retirement to withdraw the earnings. If that same 25-year-old invested that same $5,000 a year in a taxable account earning the same 8% return, she'd only have about $1 million after 40 years if her earnings were taxed at 15% each year. That's more than one-fourth less money than if she'd gone with the Roth. If state taxes bit into the earnings each year, too, she'd be down even more. Kiplinger
  3. You can take money out if you need to- Although the purpose of a Roth is to save for retirement, and your money can grow only if you leave it in the account, you can withdraw your contributions at any time, tax free and without penalty. Of course, it's best to leave your money in the account so you can earn more money, and you really should have a separate emergency savings account on standby, but it's nice to know the Roth is there for you if you need it.Notice we said you can take out your contributions at any time — not your earnings. If you withdraw any of your earnings before age 59½, you'll trigger a tax bill on the money, plus you'll have to pay a 10% penalty. On the bright side, the way the IRS looks at things, the first money that comes out of a Roth is your contributions. So it’s tax and penalty free. Only after you’ve drained the account of every penny you have contributed do you begin to dip into earnings and have to worry about taxes and penalties. And, there are even exceptions to that rule. Kiplinger
  4. If tax rates increase, money in a Roth IRA will be even more valuable than the same amount in a pre-tax account- Tax rates are currently much lower than they have been throughout much of our country's history. If taxes are increased, your Roth account will become even more valuable because you already paid the taxes on your contributions at the lower rate. Daily Fiance
  5. You will feel richer later and develop good saving skills. Diligent savers might look at the total value of their portfolio and dream about the lifestyle the sum can afford. However, when you pay taxes first, your final account balance may end up being a bit lower. However, the smaller account balance might also motivate you to kick your savings rate into high gear. Getting ahead financially is often a game of psychology. If a smaller after-tax account keeps you from wasting more of your hard-earned cash, you will ultimately be better off in retirement. Daily Fiance
  6. You can tap your Roth to buy your first home. As noted, you can always withdraw contributions tax- and penalty-free for any purpose. And, if you tap your Roth for a first-home purchase, in addition to using your contributions for the down payment, you can also withdraw up to $10,000 of earnings tax- and penalty-free if the account has been open for at least five years. Even if you fail the five-year test, the withdrawal will still be penalty-free, but you will have to pay on the withdrawn earnings. That $10,000 limit is per person, so couples could withdraw up to $20,000 of earnings if they each have a Roth. Kiplinger
  7. You can use it to save for your child's education. Many new parents don't know whether to save for retirement or the baby's college tuition. Hands down, retirement wins. There are lots of ways to borrow to finance a college education; for retirement, not so much. But starting a Roth is a great way to cover both bases, just in case. Focus on your retirement now, saving as much into a Roth as you can. And as your finances allow, consider opening a specific college-savings account for the new baby — say, a Coverdell or 529 plan. Then, when the day comes for your child to head off to school, you can assess whether you can afford to — or need to — sacrifice some of your retirement dollars to make it happen.Again, you can, of course, take out your contributions at any time to help pay the bill. If you dip into earnings before age 59½ (or before the account has been open for five years), you'll owe taxes — but you don't have to pay the 10% early-withdrawal penalty if you use the money for college. The Roth shouldn't be used as the sole savings vehicle for higher education, but it's nice to know you can use it if you need it. Kiplinger
  8. You can effectively contribute more of your wealth to tax-sheltered accounts every year. A dollar in a Roth is worth more than a dollar in a pre-tax account because Uncle Sam will eventually take a share of money in a traditional 401(k). While the annual limits on contributions to Roth and regular 401(k)s are the same, those who contribute the maximum to a Roth will effectively protect more of their wealth from future taxes than those who deposit the same amount in a traditional 401(k). Having $17,500 in a Roth account that won't be taxed again means that entire account balance belongs to you, while $17,500 in a regular 401(k) that will be taxed at the 15 percent rate is ultimately worth only $14,875. Daily Fiance
  9. Leave tax-free money to heirs-In many cases, a Roth IRA has legacy and estate planning benefits, but you need to consider carefully the pros and cons—which can be subtle and complex. Be sure to consult an attorney or estate planning expert before attempting to use Roth accounts as part of an estate plan.For instance, if you’re planning to leave your retirement savings to your heirs, consider how doing so may potentially affect their taxes. MRDs from inherited traditional IRAs generate taxable income for heirs, often during their peak earning years, which could unintentionally push them into a higher marginal tax bracket. While MRDs are also required for inherited Roth IRAs, those distributions generally remain tax free.On the other hand, if your heirs’ combined federal and state income tax rates are expected to be lower than yours, depending on the situation, they may be better off inheriting a traditional IRA rather than a Roth IRA. This may sound counter-intuitive, because the heir would not have to pay taxes on distributions from the Roth IRA, but you should consider the total tax cost—including income taxes paid by both parties as well as any applicable estate taxes—not just the income taxes paid by the heir.Because Roth IRAs don’t require MRDs during your lifetime, these accounts could potentially grow larger over the years for your heirs. And because you pay the income taxes due up front, when you contribute to a Roth, a Roth IRA conversion may also help reduce the size of your taxable estate. However, be aware that if you’re planning to leave assets to a charity rather than to your heirs, conversion to a Roth IRA has the potential to be disadvantageous. This is because in many cases IRAs can be left to a charity directly, without any tax liability to either the IRA owner or the charity. In such cases, a conversion would incur taxes that could be avoided. Fidelity
  10. Help reduce or even avoid the Medicare surtaxA Roth IRA may potentially help limit your exposure to the Medicare surtax on net investment income. This is because qualified withdrawals from a Roth IRA don’t count toward the modified adjusted gross income (MAGI) threshold that determines the surtax. MRDs from traditional (i.e., pretax) accounts such as a workplace retirement plan—like a traditional 401(k)—or a traditional IRA, are included in MAGI and do count toward the MAGI threshold for the surtax. Depending on your income in retirement, MRDs could expose you to the Medicare surtax. Fidelity

How do you start a Roth IRA?

1.Choose where you will open your account. The best way to open your Roth IRA is through an experienced investing adviser who will meet with you face-to-face. Look in your community and to your elders/friends to find out who a good adviser might be for you. We know several through our church and through volunteer opportunities around the city who we love and trust. Also, look to elders who you know have made good financial decisions over the years and seem to have planned for their retirement well. Chances are high that these beloved folks you admire also have a good financial adviser that they might recommend. These are great ways to meet/find your financial adviser

2.Gather your information and fill out the application. Your financial adviser will help you with this portion of the process. You can also expect to receive monthly reports to see how much your investment is growing. Our adviser warned us that for the first 7 years of investing in our Roth IRA it will not appear to be growing all that much (outside of our contributions being added monthly). However, after the 7 year mark, we will start to see some drastic increases. The whole point of this avenue for investing is that it is preparing you for retirement. The money will grow over time and like all good things, you have to have some patience to see it.

3.Make your initial deposit and/or set up automatic contributions. If you are financially able, it makes the most sense to contribute the monthly maximum into your account. You can only contribute $5,500 a year so the maximum monthly contribution you could make is $450 a month. The more money you can add to your account now, the more money you will be able to use in retirement in the future (tax free). With a good budget, you won't even miss it in your day-to-day.

We believe that we have made a good decision setting up a Roth IRA to save for our retirement. If you are looking for a way to invest your money that is flexible and provides you the most bang for your buck when you need it (after age 59), then this is a no-brainer for you too.

When it comes to finances we recommend talking to people you trust who seem to know how to handle their finances. Talk to your elders. Talk to financial folks who attend your churches or live in your neighborhoods. Talk to your parents if you believe them to be good financial examples. Pray about making good financial decisions and investments with your money and don't forget to do your research. 

Abundant blessings in your financial future!

The list of reasons to create a Roth IRA have been taken from informational websites like Daily Fiance, Fidelity, Kiplinger, and Bankrate.

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