Should I open a Roth IRA or just an IRA?

Question

I'm 20 years old, in collge and broke as h**l living off of my student loans for now until I find a better job when I graduate with a degree. I dont want to be broke forever, so i am thinking about what I can do to ensure a good future when I am old.

I don't know much about investing or the stock market at all. I hear that a Roth IRA is a good idea for youngsters like myself. I dont have a lot of money now to invest or save for that matter. What do you all think?

Answer 1

First off you need to have earned income in order to contribute to either of the two.

Secondly, a Roth IRA works by using "after tax" monies as the principal investment.  Therefore (as the current tax laws stand), you do not pay any taxes on the growth of the investment once you start taking distributions.  

A Traditional IRA is "pre-tax" monies.  Therefore, you will have to pay taxes on the monies once you start receiving distributions.  In addition, Traditional IRA have a "mandatory minimum distribution".  The reason for this is so that the government can "guarantee" themselves a payday in the future.

One thing that most people do not consider when they are younger is that the "taxation" or potential taxation of investments is extremely important.  So it would be wise to have "taxable" and "non-taxable" investments.  

Also consider a Cash value whole life insurance policy as well.  There are several "riders" that can be placed on this particular policy that could potential enhance the product.  One in particular is the "disability" rider.  If in fact you become disabled, the insurance company would then step in and make the monthly payments for you.  These policies have an internal rate of return.  It takes into account your overall health and age, which helps determine the premium.

The reason I would look at this product is because:

1.  At a younger age you get a pretty substantial rate of return, that is guaranteed.  Somewhere around 5-6% at your age assuming your in good health.

2.  Most people get married in life of have a child.  Therefore, it would allow you to have something in place "if need be", in the future for your surviving spouse and child/children.

3.  If you continue to make your monthly premium payment, the cash value starts to take off within 10-14 years.  These monies once you retire are available to you, and you can use the cash value earlier without a penalty.  The cash value is "TAX FREE".  

If you speak to any successful people, they will tell you "if they are forth coming with the information", that they have a policy similiar to the cash value whole life.  Any other policy is "Doo Doo" in my opinion.  85-90% of variable policies implode, and there is nothing left when your in your 50's.

Consider reading "Becoming your own Banker"

http://www.infinitebanking.org/

It's a little out dated, but still a great book.  Robert Kiyosaki "Rich dad, Poor dad" Believes 100% in cash value whole life.

Let me know if you have any other questions.

Answer 2

Individual Retirement Arrangement ("IRA"):

1. Contributions are considered pre-tax as long as your income is not not high.

" * Married Filing Jointly or Qualified Widow and Modified Adjusted Gross Income is between $83,000 and $103,000 in 2007. If you are not covered by an employee-sponsored retirement plan but your spouse is, the limits for 2007 (married filing jointly) are $156,000 and $166,000.

* Married Filing Separately (and you lived with your spouse at any time during the year) and modified AGI is between $0 and $10,000

* Single, Head of Household or Married Filing Separately (and you did not live with your spouse) and modified AGI is between $52,000 and $62,000"

Main Advantages:

If meet the income standards above, you receive a tax partial deduction on contributions to the IRA. All gains grow tax differed until withdrawn.

Main Disadvantages:

100% of contributions and any gains are taxed at ordinary income levels at whatever tax rates are in the future when withdrawals begin, no earlier than 59 1/2. Any withdrawals taken out before 59 1/2 (except below) will have an additional 10% IRS tax penalty on the full amount. And the entire amount is subject to state and federal income tax.

Exception:

$10,000 may be taken out to buy a first home with no penalty. Certain health care, and high education expenses are also exempt from penalties.

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ROTH IRA

1. Contributions are not tax-deductible, and in order to have a ROTH your income can not exceed Federal income limits.

For 2008:

" * Single filers: Up to $101,000 (to qualify for a full contribution); $101,000-$116,000 (to be eligible for a partial contribution)

* Joint filers: Up to $159,000 (to qualify for a full contribution); $159,000-$169,000 (to be eligible for a partial contribution)."

Main Advantages:

All gains grow TAX FREE.

Requirement for tax free withdrawals:

1. Must open and hold the ROTH IRA for 5 full years (don't touch = "no withdrawals"). You can still buy and sell stocks, mutual funds, Bank CD's money market, bonds, etc, at any time.

2. After 5 years, you can withdraw up to 100% of the PRINCIPLE (the cash you put in the account) at anytime with NO penalty. Best to try and keep it in if all possible - it should be geared for retirement only.

3. The INTEREST or any GAINS MUST stay in the account until at least 59 1/2 or suffer IRS 10% tax penalty on the gains only, plus pay ordinary income tax on the entire gain that was withdrawn.

Exception:

$10,000 may be taken out to buy a first home with no penalty. Certain health care, and high education expenses are also exempt from penalties.

Main Disadvantages:

No tax deductions on current tax return.

======================================...

Which is better?

In my view, the ROTH offers greater long term flexibility by allowing access to your principle after 5 years where the Traditional IRA does not.

Next, when you think 10, 20, 30+ years of growth and NOT having to pay ANY taxes on a ROTH at retirement (min age: 59 1/2), the NET growth potential of the ROTH is effectively greater because the Traditional IRA will be 100% subject to income tax in the future at whatever tax rates Congress decides.

Example:

Value of IRA in 20 years: $100,000

Value of ROTH IRA in 20 years: $100,000

Federal Tax bracket in 20 years: 20% (hypothetical)

If take out all money at once: (normally some funds taken out each year not before 59 1/2 and not later than age 70 1/2 - minimum withdraws required by 70 1/2 - determined by a life expectancy formula - "actuary table." - don't need to know all this now, because the formula will change in the future.)

Federal Tax on IRA: $20,000 (20% tax bracket)

Federal Tax on ROTH: $0.00 (any tax bracket)

State Tax on IRA: (depends on your state)

State Tax on ROTH: 0%

Best:

Max out ROTH IRA each year. Even if you quality for the little tax deduction on the Traditional IRA with your current taxes, it will cost you more money in terms of paying more taxes in the future when the money comes out. ROTH IRA avoids the government from taking your money again in the future.

Try and find a no fee IRA or Roth IRA account (Fidelity.com has one). Annual fees can reduce your overall returns in your account. If you have a retirement account with a fee, always pay the fee by writing a check each year instead of debiting the account for the fee.

Answer 3

Roth IRA = investment savings account in which you pay the taxes now

IRA (traditional IRA) = investment savings account in which you pay the taxes later

My guess is you would be better off paying taxes later, like when you retire as your income will be low (similar to now though - but I am betting you can use every penny now and also take advantage of compunding)

My advice, go with a traditional IRA. However, Roth IRA's provide (allow) for different things than traditionals, such as not having to pay taxes if your investment will be for a first home purchase (among other things).

read up on both.. wiki has some good info

Answer 4

I would go with a Roth Ira since it sounds like you will pay no or little taxes anyway this year. Revisit this issue after graduation, since the numbers will change completely.

Answer 5

Very impressive that you're thinking about your future at this stage of your life.  You are doing yourself a HUGE favor by starting now.

A Roth IRA is definitely the way to go.  Set it up with a good mutual fund company (my personal favorites are Vanguard, T. Rowe Price, and Fidelity), and tell the phone rep about your situation.  All fund companies will waive their investment minimums (usually $1,000 to $2,500) if you sign up for automatic monthly investments from your bank account (minimum $50-$100 per month), which is the best way to go in your situation.

To start off with, tell them you want to invest in a large company stock index fund.  Most fund companies (including the three I mentioned) have an index fund that tracks the S&P 500 - basically, the 500 largest companies in the U.S.  If you go with Vanguard, they also have one called the "Total Stock Market" index fund - either would be an excellent starting investment.

Note that stock index funds will fluctuate both up AND down in value, but over the long term they are a great investment.  On average, the ones I described have returned around 10% per year.  At that rate, your $100 a month would become over $200K in 30 years.  Of course, as you progress in your career, you'll be able to increase your monthly investment, as well as participate in your employer's 401(k).

Congratulations on getting an early head start with your retirement planning - you will NOT regret it.  Good luck!

Answer 6

Roth IRA's give you great tax benefits in the future, but nothing in the current year.  Traditional IRA's however, give you a current tax year break, but when you take withdrawals (assuming you follow the rules) you will be taxed at your tax rate.

The main key is that most younger people do not need a current year tax break...most of us receive tax returns instead of paying taxes.  The thought is that in the future we will need more of a tax break as our income grows, and that is when the Roth pays off, since there are no taxes when you take money out.  none.  zip.  (as long as you follow the rules).

So...take that for what it is worth.  You are limited in the amount ayou can contribute to IRA's too, remember that.

-Quick note about the answer preceeding mine.  He makes it sound like yo upay taxes from your Roth IRA every year.  This is not true, as both Traditional and ROTH IRA's grow tax deffered.-