For Millennials, Retirement may seem like a long time away. However, the sooner you begin investing, the more you will see your retirement dollars grow. There are many different account types, but a Roth IRA is often the most effective vehicle to build a nest egg for your financial future.
What is a Roth IRA?
A Roth IRA is an individual retirement account which allows the owner to contribute after-tax dollars – that grow tax deferred – and can be withdrawn tax free in retirement. In other words, each year you can put in up to $5,500 into a Roth account, not pay any taxes on the growth of the account, and when you are 59.5 you can take it all out tax free!
“The importance of a tax-free nest egg to your financial future can’t be overestimated,” says Robert Katch, President and CIO at Manchester Financial Advisors.
Why a ROTH IRA vs Traditional IRA for Millennials?
When it comes to your financial future, a dollar in a Roth IRA is (almost) always worth more in retirement than a dollar in a Traditional IRA. This is because the tax has already been paid on contributions.
Let’s assume most millennials are currently in their lowest tax bracket years. That means Roth contributions, which are not tax deductible, will most likely cost you less now since you are in lower tax brackets, but cost more as you continue in your career and enter higher tax brackets.
Also, if you eventually have a high enough income, you won’t be able to contribute to a Roth IRA. If your goal is to maximize your retirement savings for your financial future, not to lower your current tax bill, a ROTH is usually a better option.
In addition, the Roth IRA allows you to remove contributions (not earnings) without any taxes or penalties at any time, for any reason.
Other Points to Consider
Contributions may be made to a Roth IRA even if the owner participates in a qualified retirement plan such as a 401(k) and you can usually withdrawal the earnings tax free after age 59.5.
Also, there is no point at which you must withdraw or stop contributing to the account.
This differs from a traditional IRA which requires you take money out at age 70.5 in the form of a Required Minimum Distribution (also known as an RMD).
If you think you will be in a higher tax bracket in the future, a ROTH IRA is a great vehicle for retirement savings now. It also allows you to add some tax diversification to your portfolio if you participate in a 401(k) or other pre-tax account.
“By considering your options at a younger age, investors can set themselves up for the retirement they want,” said Alan Hopkins, Manchester Financial Chief Economic Strategist.