—Greta J., third-year graduate student, The College of St. Scholastica
As a college student, should you be thinking about retirement? The answer for most people is “yes,” but that doesn’t always mean everyone should take action just yet. A great way to start planning for retirement is to familiarize yourself with the different options available, so that you’ll be more prepared when you feel ready to start saving. One popular way to save for retirement is a Roth IRA.
What is a Roth IRA?
A Roth IRA (individual retirement account) is a type of retirement account that allows tax-free growth during its lifetime. This means that once you put money into your Roth, you are not taxed on that money or its earnings when you retire, because you’ve already paid the taxes on the money you put in. In comparison, a traditional retirement account, such as a 401(k), is tax-deferred, meaning you don’t pay taxes when you contribute the money. However, you’ll need to pay taxes on it when you start withdrawing at retirement.
Although the tax-free withdrawal piece is usually the biggest draw of a Roth IRA, another great benefit is the ability to withdraw money you contributed after five years without taxes or penalties—even if it’s before your retirement. (Traditional retirement accounts, on the other hand, are subject to a penalty if you make withdrawals before retirement age.) Life happens, and this can be convenient if you have an unexpected medical issue or you’re hit with a significant expense you didn’t budget for. Just keep in mind that the tax- and penalty-free rule only applies to the money you initially contributed to the Roth IRA. Any interest that your account accrues over time will be taxed if you withdraw it before retirement.
You can still withdraw money from a Roth IRA before the five years are up, but it will be subject to a 10 percent early withdrawal penalty. The good news is that there are a few exceptions to this rule: for instance, if you are using the money to buy your first home or to pay for higher education.
Opening a Roth IRA
Although you can open a Roth IRA through an online provider, you might consider first talking to your bank or an investment company to learn more specifics. Each of these providers may have different requirements for starting an account. Consider starting with the bank that you already do business with by asking whether they have an investments department that offers Roth IRAs.
Contributions
Most individuals under 50 years old can contribute up to a maximum of $6,000 per year toward their Roth IRA. That doesn’t mean you have to contribute the maximum—you might start by contributing just $50 per month for a total of $600 for the year. Keep in mind that the earlier you start contributing and the more you contribute, the more your returns will be when you retire.
Your contributions can continue as long as you are within specific income limits. For most single individuals, you can contribute to your Roth IRA if your adjusted gross annual income is under $129,000. These limits will vary based on your filing status.
Is a Roth IRA for me?
A better question is: “Is a Roth IRA for me now?” Everyone’s situation is different, and as a college student, you need to think of your finances holistically. Although you want to make sound investing choices early to save for retirement, you also need to consider your debts, like student loans. Do you have federal loans? Private/alternative loans? Both? If the answer to any of these questions is yes, think about the interest rates on those loans and how long it will take you to pay them off. While opening a Roth IRA can begin the process of investing for your future, any earnings that come from your Roth could potentially be canceled out by interest charges that accrue on your existing loans.
A good time to consider your retirement options may also be after graduation. Consider your income and debts, and then look at any money left over—this will be what you can potentially contribute to savings and retirement accounts. Think about talking to a financial advisor, too—they can review your individual situation and goals with you and help you understand what options might be best for you and your future.
