FINANCIAL FRESHMAN #006

TL;DR → Roth IRAs are an ideal retirement savings vehicle due to their tax advantages. If you meet all requirements to contribute to an IRA, consider starting as early as you can to capitalize on decades of compound growth in the market. Opening a Roth IRA is as easy as identifying a provider, completing an application, and funding your account.

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College Students and Retirement

If you are a current college student or a recent graduate, retirement saving might not be high on your list of priorities. However, it will prove incredibly valuable to you to understand the different retirement options that are available. Additionally, if you are fortunate enough to be able to begin a contribution this early in your career, you will be extremely well-positioned when it’s time to actually retire. Among the various retirement vehicles, the Roth IRA stands out as one of the best options.

What is a Roth IRA?

Put simply, a Roth IRA is a tax-advantaged retirement account. Let’s break down that vocabulary.

• Roth – This type of account is named after Delaware Senator William Roth, who was an initial author of the Taxpayer Relief Act of 1997. This is the law that gave us the Roth IRA.
• IRA – Individual Retirement Account
• Tax-Advantaged – We say that an account is “tax-advantaged” whenever it offers tax benefits, either in the present or future. In the case of the Roth IRA, your contributions will be made with income that you will have already paid taxes on. Because of this, you will not pay additional taxes on the contributions or accrued interest when you withdraw the money in retirement, provided that certain conditions are met.

What Are the Rules?

Because of the tax benefits, there are certain rules that apply to Roth IRAs. The main four to be mindful of are contribution limits, contribution deadlines, income limits, and rules of withdrawal.

• Contribution Limits – As of August 2024, an individual is only permitted to contribute $7,000 per year to a Roth IRA. If you are over the age of 50, that allowance grows to $8,000.
• Contribution Deadlines – You can contribute to your Roth IRA for any calendar year until April 15th of the following year. For example, contributions towards the $7,000 limit for 2024 can be made until April 15th, 2025.
• Income Limits – As of August of 2024, Roth IRA contributions are only allowed for single individuals making less than $161,000 and for married couples making less than $240,000.
• Rules of Withdrawal – You may withdrawal your own contributions at any time without penalty. Penalty-free withdrawal of earnings is only available after you turn 59.5 years old. There are some life events that may allow for early withdrawal without penalty, such as buying your first home, covering emergency medical expenses, or paying for a birth or adoption.

Why Start Now?

The benefits of starting a Roth IRA early in your career can be summarized in one statement – more time for compound growth in the market. To understand the value of long-term compound growth, let’s look at two hypothetical investors.

Let’s call Investor #1 Amanda. Say that Amanda opens a Roth IRA account when they turn 22 years old, and contributes $2,000 per year for ten years. After they turn 32 years old, they completely stop contributing to this account. They go on to retire at age 65, only having ever contributed $20,000 in total.

Investor #2 is Patrick. Patrick doesn’t open their IRA until they are 32 years old, but starts contributing the same $2,000 per year. They continue this contribution all the way until their retirement at age 65, contributing $66,000 in total – over three times the amount that Amanda contributed.

So, who has more money when they retire at 65? Amanda does by about $20,000, despite having contributed only 30% of what Patrick did. Don’t believe me? You can find the calculations in the Appendix below, right above the box to subscribe.

How to Open a Roth IRA as a College Student

Opening a Roth IRA is a fairly straightforward process. Here’s a step-by-step guide to help you get started:

1. Check Your Eligibility – As a college student, if you have earned income from a job, you qualify to contribute to a Roth IRA provided your income falls within the specified limits.
2. Choose an IRA Provider – Research various financial institutions that offer Roth IRAs, such as banks, credit unions, and online brokerage firms. There will be dozens of options, so make sure you compare fees, available investment options, and user-friendliness of the platforms. Look for institutions with low minimum deposit requirements, as this is especially important for college students or those early in their career.
3. Complete the Application – You will need to provide some personal information, including your Social Security number, driver’s license or other ID, as well as bank account information.
4. Fund your Account – After your account is established, you can fund it through direct deposits from your bank account or by transferring funds from an existing account. Make a plan to contribute consistently, even if it’s a small amount. This amount can grow as your income grows.
5. Start Investing – Keep in mind that depending on your IRA provider, your funds may not be automatically invested. Oftentimes initial contributions will be sitting in a savings account, waiting for the account owner to allocate them to a specific investment. Consider a low-cost index fund, target date fund (TDF), or diversified exchange-traded fund (ETF).

Final Thoughts

Opening a Roth IRA as a college student or recent graduate is one of the best financial decisions you can make. By starting early, you can take advantage of decades of compound growth, allowing your money to work for you over time. The tax benefits and flexibility of a Roth IRA make it an excellent choice for building your retirement savings. Your future self will thank you!

Appendix – Amanda vs. Patrick