My 18 year old nephew has a Roth IRA. Should you?


This year, my eldest nephew graduated high school and entered the workforce.

So naturally, as this is his first year of working, I talked to him about his last year of working. Yep, for his graduation gift, besides a little cash for spending now, I gave him some cash to open up his ROTH account. Now, my 18 year old nephew not only knows what a ROTH account is. He has one.

Should you?

 

Definition: IRA: Individual Retirement Account: allows you to save money specifically for retirement with a tax advantage. Two types of self directed IRAs are Traditional and Roth.

 

Traditional: Tax Advantage: Save Some Now

Established in 1974, and once described as the biggest tax break in history, a traditional IRA allows individuals to invest PRE TAX dollars and delay paying taxes on that amount until time of withdraw.

  • Upon withdraw pay taxes on both the original investment plus the interest it has earned.

  • The government is going to eventually want their taxes, so even if you don't need the money you HAVE to start withdrawing at age 72. This is called an RMD or Required Minimum Distribution.

Roth: Tax Advantage: Save Even More Later

Established in 1997, it was named after William Roth, a former Delaware Senator. This account is funded with POST TAX dollars and therefore requires no tax payment when you withdraw.

  • This is huge and worth repeating: So 'Ill say it again: Withdrawing Roth funds is completely tax free. Both the original investment and, even more importantly, the interest earned are tax exempt. To be super clear: This is free money.

  • There are very few situations that you can earn money and not be required to pay taxes on it. Over your lifetime, you will likely pay taxes not only on your income but also on real estate equity, 401k earnings, stock investments, and even on a regular ole' interest bearing savings account. But you will not pay taxes on the interest earned from a Roth account. That is what makes the Roth IRA so valuable.

  • Since you are not going to pay taxes on your withdrawn funds, the government does not care if you ever withdraw from it and there are not rules forcing you to withdraw. This means the funds can continue to grow tax free for as long as you choose!

 

Despite the tax differences, there are several SIMILARITIES for both types of IRAs:



  • WHO? The word "Individual" is right there in the title and, while your account should have a designated beneficiary, there are no joint IRAs. Each account is in one persons name.

  • WHAT? In each account you can purchase the same types of investments. Choose from any security such as stocks, bonds, mutual funds, ETFs, etc.

  • WHERE? You can open up an IRA at your local bank, a brokerage house like Fidelity, Charles Schwab or Edward Jones, an online financial intuition such as Vanguard, or Robo Advisors including Ellevest or Betterment.

  • WHEN TO INVEST? You are allowed to invest for the prior tax year until April 15 (tax date) of the following year. That means for 2020, you can contribute up till April 15 2021. For 2021 you can contribute between January 1 2021 - April 15 2022. So yes there is always some overlap.

  • HOW MUCH?: In 200 and 2021, the contribution limit to contribute to IRAs is $6,000 a year. Those turning, or already, age 50 or older can take advantage of catch up contribution and invest up to $7,000. These funds can be split between Traditional and ROTH or used solely to fund one type of account.

  • WHEN YOU CAN WITHDRAW: Either type of IRA allows you to start taking penalty fee withdraws starting at age 59.5 years. (Bonus: Roth also allows you to withdraw up to your contribution amount tax and penalty free at any time giving it even more flexibility).

So What's The Catch?

While calling it a catch might be overly dramatic, there are a few key potential pain points to consider as you plan when and where to save your income for retirement.

Contribution Limits:

If not already, eventually, you might be in a position to save more than $6k a year towards retirement. But because IRA accounts have significant tax benefits, the law limits how much of your income you can contribute. Because whether you pay it now or later, the government plans to collect some income tax revenue. Therefore, if you have more than $6k to invest, consider using an IRA to supplement another retirement savings account such as an employer sponsored 401k.

Contributing to multiple types of accounts allows you take advantage of different tax benefits and maximize your cont