IRA or Roth IRA...what should I do?

Question

If I am 20 years old what should I do to save money? I don't have a huge amount to put into an account, but feel that it would be smarter to do it now then when i'm 30 or 40. Any tips on getting started?

Answer 1

Good question -- typically your age comes into play when answering this question. You can contribute up to 4000 per year with a Roth IRA and this money will grow each year (compounding interest is a very powerful thing).

Since you are only 20, you will have many years of tax free growth with a Roth IRA -- you won't get a tax break up front with a Roth but you never have to pay tax upon withdrawal down the road.

A traditonal IRA is tax deferred so you will accumulate a similar amount of money but will pay tax upon withdrawal. There is a "phase out" with both types of IRA's which is essentially a limit that kicks in at the 100K range to reduce the amount you can contribute. The reason I mention this is that if you should start now so if your profession takes you into a high income bracket, this may eventually limit your ability to contribute.

Short answer -- no brainer for you, a Roth IRA. Contribute as much as you can now (up to the limit) and compound interest will make this account grow exponentially over the years...when you leave an employer you can roll over your 401K's to a traditional IRA and then convert the traditional IRA into a Roth. I have done this a few times...you have to pay the tax on the conversion but the fact that you will never have to pay tax on the proceeds from your Roth IRA come retirement will far supercede the pain upfront.

This advice would be totally different if you told me you were 45. Good luck -- smart person starting an IRA now!

Answer 2

Good for you! You are very smart to start saving for retirement now. I little bit now will add up to a lot later.

I would suggest a Roth IRA - because you pay with post-tax money. Then, when you withdraw the money, you won't have to pay taxes on it (maybe on the growth - but not on the principal - check with your accountant or the place where you're getting the IRA.)

With a regular IRA, you don't pay taxes on the money your put in now, but you will when you withdraw the money, and the way this economy is going that could be a hefty amount. I work with a financial planner and she's getting us to switch to Roth IRAs for this reason. So you can benefit from her advice for free.

Answer 3

If you expect to have a lot of income when you retire then a Roth IRA is better. You pay taxes on the money you put in now, but you will never pay tax on the earnings. But if you need to save on taxes now then a regular IRA will help you because the money you put in now will not be taxed as income, but in retirement it will be taxable.

Edit: (On a Roth IRA you won't pay taxes on the growth either, except if you withdraw the money before retirement).

Answer 4

Roth IRA, for the reasons mentioned above.

Also, as your income level rises keep the maximum limit in mind (right now it is 100,000). There are no warning signs that you will go over it and it could prove an expensive mistake (6% penalty tax per year).