I was trying to think of a fancy way to explain the concept
of Roth IRAs and how all young professionals should take advantage of this
investment vehicle because of their (your) low income tax bracket and couldn’t
think of one – I’ll blame it on writer's block.
So here it is plain and simple…
An Individual Retirement Account (IRA) is another investment
vehicle to put money aside to save for your golden years. Instead of relying on your employer to
sponsor this account for you, you can establish this one on your own. Not so fast…
In order to invest/contribute to this type of plan you have to have
“earned income”. Earned income simply
means you had a job during that contributing tax year.
There are two types of IRAs - Traditional and Roth.
A traditional IRA allows you to invest pre-tax money into an
account. (Think of pre-tax money as dollars never hitting your hand). You do
not pay taxes on the contributions or earnings until you take a distribution
from the account at age 59 ½ or after.
The Roth IRA is the complete opposite.
With a Roth IRA you invest post-tax money into an account
and you do not pay taxes on the contributions or the earnings when you take qualified
distributions. (Think of post-tax money
as dollars hitting your hand, meaning you have already been taxed on it). Just in case you missed it, you do not pay
taxes on the earnings of your investment… Why is this so sweet, especially for
Gen Y? Well… right now (theoretically)
you're at a low earning point in your life which translates to a low Federal
income tax bracket.
Unlike a traditional
IRA, defer paying taxes, with a Roth IRA you pay taxes now so when it
is time to take a qualified distribution from your account it is tax free!
- Quick example: you invested $50,000 over the years and it has grown to $70,000. When you reach age 59 ½ (or after) and you want to take out the entire $70,000 you can without paying taxes. Gosh I hope you are as excited as I am.
Another sweet feature to Roth IRAs is you can, at any time,
withdraw your contributions (not your earnings) at anytime without paying
taxes.
- Quick example: you invested $50,000 over the years and it has grown to $70,000. You can withdraw $50,000 at anytime without paying taxes. If you touch the earnings before reaching 59 ½ OR it is not a qualified distribution, you will be subject to taxes and a 10% early withdrawal penalty.
Where to establish my
new Roth IRA?
Now you are as excited as I am about (yet another) savings
vehicle, where and how do you establish a Roth IRA? I found this great post that explains the
different type of places you can open a Roth IRA. Check out the post here: Best
Places to Open and Setup Roth IRA.
I want to make sure this message is clear…It is so important to take advantage of these investment opportunities now. I found this jargon free video that explains the benefit of contributing to a Roth IRA. This is what I call great golden financial nuggets!
Check out this video: How to Pay Taxes Like the Rich
Rianka D.
~~~~~~~~
Useful link : What the IRS has to say about IRAs
Boom, Bam, Pow....another banger!
ReplyDeleteThank you!
DeleteQuestion if I have the traditional can I just switch it over to Roth? And if so, how does that effect money that I have already contributed?
ReplyDeleteHi Alexandra, this is a great question!
DeleteYes - you can switch your Traditional IRA to a Roth IRA, this is called a Roth Conversion. BUT... when you covert your Trad IRA to a Roth IRA you will have to pay taxes on the amount you are converting (if it is pre-tax money) and also pay taxes on the earnings.
If you use the money you have contributed to the Trad IRA to pay the taxes, then you will have to also pay a 10% penalty because this will be considered an early withdrawal (I know you are not 59 1/2). :-)
I hope this answer your question!
Rianka, thanks for all the financial advice and guidance. God has truly blessed me with you...Question, is there a minimum amount of money you need to open a Roth IRA?
ReplyDeleteThank you, TK. Very sweet of you. :-)
DeleteThere may be a minimum amount of money you need to open a Roth IRA, it mainly depends on the financial institution requirements.
For example, if you choose to open a Roth IRA at Vanguard - the minimum investment may be $1,000. However, if you open it at T. Rowe Price there may be a minimum investment of $1,000 BUT the minimum investment requirement may be waived if you make elect to make automatic contributions of $50 a month to your account.
To make my long answer short... it depends on where you open the Roth IRA. :-)
(The above financial institutions requirements are just examples).
I've been working and saving up money for the past year and a half, but now I'm going back to school. Would setting up a Roth IRA make sense for someone starting dental school next year? I'll have zero income for the next 4 years.
ReplyDeleteHi there... Congrats on the accomplishment of attending dental school next year and good luck!
ReplyDeleteIn order for you to contribute to a Roth IRA, you have to have earned income. If you are not working while in dental school then this type of savings plan will not work in your favor. If perhaps you have a side job and earning income while in school then you can contribute to this type of account.
Thanks for your question!
Nice post, very helpful for us.I will come back here again & again...:)
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