“I think I understand what it is, but why should I have a Roth IRA?”
~New college grad at last week’s workshop
Good question. I think there are many things in life that are more confusing than they need to be and this is sure one of them. Let me walk you through what a Roth IRA is, why you want one, and how to get one.
After all those years in school it is a glorious day when you finally receive your first real paycheck. Final exams are history, you have no homework assignments due, and now you are getting paid for doing something you enjoy. Of course, the taxes kind of stink but that’s a blog for another day. And, perhaps it’s a stretch to say you are loving what you’re doing but that will come with time. It’s good enough for now and it is thrilling to live completely in the present. Most of what we do is focused on the present but the Roth IRA is about doing a little something for your future.
IRA stands for Individual Retirement Account. An IRA is an account you open at an investment firm such as Charles Schwab, Fidelity, or E*TRADE (No Fees. No minimums.), to save money for that future date when you no longer want to work. You might have Social Security retirement benefits and you might have a pension but it’s likely that you’ll need more than either of those will provide. The IRA enables you to take control of your future by allowing you to invest up to $5,500 per year in this account.
There are several different types of IRAs and the Roth IRA is the one that is ideal for anyone who is eligible to participate. Former U.S. Senator William Roth (R-DE) suggested we should have a way to a let people put aside money that has already been taxed and let it grow tax-free for retirement. Congress agreed that it was a good idea (I know you just read that last phrase twice – congress and agree are not words we see together very often, do we?) and there you have it. Not only does the money grow tax free but when you do retire, you can take the money out tax free as well. The sooner you start and the more diligent you are about putting the full $5,500 in the account each year, the faster your money will grow.
How does a Roth IRA grow?
By investing your Roth IRA dollars in stocks and bonds you will see your total grow.
What are Stocks?
Stocks are actual shares of companies like Microsoft or General Electric. By owning shares of their stock, you benefit from the growth of these companies.
What are Bonds?
Bonds are loans. A company or government wants to borrow money so they issue bonds. You buy the bonds to give them the money and they pay you interest until the bond ‘matures’ and they pay back the full amount they borrowed.
Investments have risk and no guarantee of return so stock and bond prices can rise and fall but over the long run, they increase in value. This means your Roth grows two ways – through the money you add to it and through the earnings of your investments.
When you are just starting out, how should you invest a Roth IRA?
Choose a Target Date or Life Cycle fund. These funds contain a mix of mutual funds that hold stocks and bonds so you are spread across different types of investments. As your Roth IRA grows, you may want to work with a financial planner to select specific investments to meet your individual goals. Start investing $5, 500 a year at 22 and you will have over one million tax-free dollars by age 60! (assuming an average 6% rate of return on your investments. The best place to open your Roth IRA is at a high-quality low-cost major institution such as those mentioned above. Everything can be done online in about 10 minutes – including the all-important automated transfers from your checking account to put your wealth-building on autopilot.
Start building your Roth IRA account dollars today as part of your plan to take control of your finances. Because no one wants to work forever.
Download Step by Step Directions: How to Open a Roth IRA