Retirement may be far away for those of us who haven't even secured our first job out of college, but the benefits of saving for retirement are quite relevant to even the youngest contributors. Opening a Roth IRA, for example, benefits college students because the sooner you start investing, the more time your money has to grow. We must emphasize that while Roth IRAs are used to save money, they also involve investing which can certainly have its risks. As such, we intend to explore the ways in which starting early in any investment scheme can be incredibly beneficial. The way you invest is ultimately your choice, and we hope that the following resources will help you in your research, whether or not you decide to open a Roth IRA.
The Department of the Treasury has a comprehensive guide to all types of IRAs available on the web here. Make sure you read up on any investment strategy through a trusted entity before reading editorials or user feedback. One of the most important skills you gain in college, distinguishing primary sources from secondary sources, will help you make prudent decisions with your finances.
Before we give you examples of how the Roth IRA works, we'll define some terms to make you more familiar:
1) Contributions vs. Earnings
When we say that you can withdraw contributions from the Roth IRA without penalty, we are only referring to those cash amounts you have actually contributed. Contributions do not include the interest earned on the cash amounts.
2) Seasoning Period
The "seasoning period" refers to the first five years the account is open. A Roth IRA will not allow you to withdraw contributions without taxes or penalties until the seasoning period is over. Whenever we refer to the benefit of withdrawing contributions or earnings, please keep in mind that it only applies to the time period following the seasoning period.
Roth IRAs aren't just used to save for retirement. Once a Roth IRA account is past the seasoning period, individuals may withdraw up to $10,000 of their earnings if they are purchasing a primary residence for the first time. This means that you can simultaneously save for your first home and your retirement. As we've emphasized before, having short and long term goals are important in motivating you to save money, and we think that owning a home and securing a comfortable retirement are excellent goals to have.
Just to exemplify how starting early can result in larger returns, consider our fictional friend Mike in his Roth IRA endeavor:
At the age of 19, Mike decides to open a Roth IRA. He vows to contribute $1,000 per year every year until he retires. If the standard return rate is 7%, Mike will find himself with $229,632 at the age of 60. If he waits until later in life to retire, this amount will increase.
Mike's older brother Max decides to join him in his endeavor. He too opens a Roth IRA, but because he makes considerably more money a year at the age of 30, he contributes $2,000 per year and doesn't touch the balance until he retires. At the age of 60, Max comes out with $202,146.
This example demonstrates that contributing less to a Roth IRA earlier in life has its benefits. Even though Max contributed more over his lifetime ($19,000 more, to be exact) and more per month, he ended up with less than his younger brother.
Check out this website to calculate Roth IRA returns with different numbers. To see how much you could earn on a Roth IRA after a few years, try this site.
We'll be sure to update our "Another Way to Save" series with more investment and saving options. Always remember to do your research and consult an expert if necessary before investing! If you have any suggestions or want to know more about the Roth IRA or other investment/saving venues, leave us a comment with your questions.
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