"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?
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
- 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.
- More Money for Retirement- For 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 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
- 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
- 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
- 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
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.
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.