For university graduates entering the workforce, the vast array of retirement options may be confusing and overwhelming. Should I contribute to a 401(k) plan? How much should I contribute? What about an individual retirement account? (For more, see: Retirement Savings Tips for Young People.)
One of the best vehicles for 20-somethings is the Roth IRA. You contribute money that's already taxed, so when you withdraw from the fund later in life (starting at age 59), you don't pay any taxes on the money. This is a key feature of the Roth IRA for young people. When you're not earning a lot, you're in a lower tax bracket. If you put away earnings in a Roth IRA now, you pay lower taxes than you would when they're distributed (and you're likely to be in a higher tax bracket). So the earlier you can get money into an account like this, the longer those assets will have to grow tax-free, says certified financial planner Cristina Guglielmetti, owner of Future Perfect Planning. (For more, see: Tax Treatment of Roth IRA Distributions and Roth vs. Traditional IRA: Which is Right for You?)
Timing is EverythingThe Roth IRA comes with limits. If you're single, you are only eligible to contribute to a Roth IRA if you make less than $131,000. If you're married, that amount increases to $193,000. Good news for those in their 20s: Even the average 30-year-old doesn't earn that much. Instead of lamenting your low income, you can contribute to a retirement account that might not be an option in a few years. This is especially important for professions where you start slow and end up making a lot more after a few years. (For more, see: How to Start Saving for Retirement.)
We typically make less money when we are younger, so we should take advantage of the fact that we can contribute to this great retirement vehicle while we still can (since you're less likely to hit that income limit while you're young, it's important to take advantage because this option might not be around forever)," says Eric Roberge, CFP and founder of Beyond Your Hammock. (For more, see: 5 Essential Retirement Savings Accounts.)
You can only contribute $5,500 a year to a Roth IRA, Roberge points out. This means you miss out on the opportunity to contribute if you wait too long — until you're earning more money, for instance. So even if you can't contribute the maximum, you still should try to put some money aside in a Roth IRA. (For more, see: Comparing Contribution Limits: Roth 401(k) vs. Roth IRA.)
No Time Like the PresentStarting to save while you're young — whether it's in a tax-deferred or taxable vehicle — is more important than waiting until you can afford to do more. The younger you are, the more you'll benefit from compound interest. (For more, see: How Often is Interest Compounded?)
CFP and owner of Sheehan Life Planning, Dan Sheehan said he made his children start putting away $2,000 a year into a Roth IRA when they were 18. If they started putting that money away at age 30 instead, they would earn more than $1 million less by age 65 (assuming a 10% interest rate). The sooner you begin to invest, the more you'll be rewarded. The best part is that you don't have to invest a lot. Even a $100 a month starting at age 25 will yield huge rewards. (For more, see: It's Never Too Early to Start Saving.)
If you need money, you can withdraw from your Roth IRA. That said, it should not be viewed as an emergency fund that's earning great interest. This is an investment you're making for your retirement, not for a down payment on a house or your kid's college fund. By putting your money aside while you're beginning your career, you're developing habits that will ensure a full balance when you're ready to retire. (For more, see: Best Savings Priority: Retirement vs. College Fund.)
If millennials can grasp and accept the idea of saving and investing early while delaying some things they want, but really don't need, they will have the ultimate experience when they reach their retirement years — financial security and peace of mind, Sheehan said. (For more, see: Are Millennials all about Responsible Investing?)
The Bottom LineSaving for retirement is important — and it's important to start doing so early. For young people just entering the workforce who aren't earning a high salary, a Roth IRA is a great investment vehicle. It allows you to put money aside while you're in a lower tax bracket and earn compound interest on that money over the course of your working life. Even a small amount contributed each year will result in significant funds for retirement down the road. (For more, see: Top 4 Retirement Savings Mistakes to Avoid.)