Graduated Learning: Life after College

I got my degree, I got a job…now what?

Should everyone contribute to a Roth IRA? November 10, 2011

Filed under: Personal Finance — Stephanie @ 5:26 pm
Tags: , , ,

The short answer?  No.  It’s not perfect for everyone.  And actually, not everyone is eligible for it.

Roth IRAs are the Big Thing these days for younger people looking to save for retirement.   We’re all encouraged to open one, and contribute to it.  Seems like it doesn’t matter what fund you buy.  Your mission (from the personal finance gurus) is to put money in there.  Put all $5k in there if you can.  If you’re doing that and contributing to a 401(k) up to at least any employer match, you are on the right track (according to gurus, and to be honest, according to me, too!)

My younger sister is currently in grad school.  She sent me a message the other day, with the basic question:  Should I open a Roth IRA?  What are your thoughts on this?

My response?  A combination of advice and general information.  Read on:

They’re a good idea.  It’s good to start saving for your retirement now.  Plus with the stock market down, you buy funds “on sale” 😛

I maybe sound like a salesperson.  Ooops.

You can contribute up to $5000, or your income (what shows up on your W-2s), whichever is lower.  But I’m assuming your stipend is more than $5000!

Also, not sure what your stipend is, but if you make less than $27,750, you can get up to $1000 tax credit if you contribute to a retirement fund

The benefit of contributing to a Roth IRA right now is, of course, “The Power of Compounding”.  There’s a common example that if you contribute now and for only a few years, you’ll have more money than if you start later and contribute longer.  Magic.  Assuming the markets go up!

With a Roth IRA, you’re paying in money that was already taxed (through your employer), so when you contribute to your Roth, it can now grow tax-free (and be withdrawn tax-free when you retire).  And since your income level isn’t super high right now, your tax rate is relatively low.  Presumably, in the future, your tax rate will be higher, so if you had used a traditional IRA, while you don’t pay tax now (or you get a tax refund now, depending on how you do the IRA), you’d have to pay taxes on the money you take out of the account (when you retire).  So taxes might be higher then.  It’s a bit of a hedge, because it’s hard to know for certain what rates will be.

Lastly, if you’re mildly freaked out by the idea of putting a lot of money into an account, don’t worry.  Two parts make it less scary:  1.  You are able to withdraw your CONTRIBUTIONS at any time without penalty.  So, you can take out that money.  2.  You don’t have to put the whole $5000 (or however much you decide to contribute) all at once.  I contribute 1/12th of the total amount every month, and buy into a fund every month.  The idea of “dollar cost averaging” will work in your favor, here.  The basic idea is that you buy some of the fund every month, and you buy more when it’s “cheaper” (when the stock price is down), and less when it’s more expensive.  That way you don’t have to worry so much about putting all your eggs in one basket and trying to time the market perfectly.  Because that’s basically impossible.

As for what fund to invest in, most companies offer a fund geared at your particular retirement year.  So you can just contribute to the 2055 fund or something like that, and it’ll start out being more aggressive, then transition to being more conservative as you get older.  Another good option (often with much lower fees) is an index fund.  You’ll want to put your money in a fund with a low expense ratio (read:  cost) so that more of your investment goes to you and less to fees.  Usually it’s hard to buy certain other funds or individual stocks/bonds when you’re just starting out, because you need to have a pretty large minimum amount.  So you can build up your retirement fund until you have enough money to diversify, or you can just keep it in the lifecycle fund that fits your age or an index fund.

So.  If you want to start saving for your retirement (and you should!) I think Roth IRAs are a really good way to start, and it’s good to start now when you make less money (you can’t contribute if your AGI is over $107k…you know, SOMEDAY you might make that much!) and while you’re in a relatively low tax bracket.  It’s hard to know where the markets or tax rates will go, but I’ve found my Roth IRA to be a great balance to my employer’s 401k plan.

(Reminder, I’m not a financial advisor…I’m just a girl who likes talking about money!  But if you have any questions, I’ll answer them!)

Do you have a Roth IRA?  Traditional IRA?  Do you max out your contributions every year?

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5 Responses to “Should everyone contribute to a Roth IRA?”

  1. We just opened Roth IRAs a few months ago- as grad students, we also have a low tax bracket and no 401k plans, so it seemed like our best option. Our plan is to max them out for this tax year, and every year that we’re eligible in the future 🙂

    Before we started contributing, we spent some time freaking out about what would be the best options, but eventually came to the realization that doing SOMETHING was better than nothing, and we’re starting out with target date funds. The great thing is that we can always change what we contribute to over time, but now we’ve got something set aside for retirement, and that feels pretty good.

    • Stephanie Says:

      Yeah, I agree, it’s good to get started, even if it’s a little bit of money. I noticed that the target date fund I’m investing in has a relatively high expense ratio, but it was definitely good to start with something. So now I’m moving some money into index funds and other lower cost funds. Glad you’ve gotten started! 🙂

  2. Megan Says:

    Hey Stephanie — nice blog! This was the same advice I gave to my sister back when she was in grad school, so it’s good to know I wasn’t way off base 🙂

  3. shademar Says:

    If you’re using a 1098-t or 1099-t to report income from stipends, you may be setting yourself up for trouble. From what I can tell this doesn’t count towards Earned Income, thus making your stipend ineligible for Roth contributions. Sounds crazy but I’m realizing everything I set aside during grad school may have been an ‘excess contribution’ and subject to tax penalties that accrue by the year. I don’t even know how to begin to correct this…nobody seems to understand the situation well enough to give advice.


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