How Roth IRAs Give Gen Y a Fighting Chance

Posted in IRA , Retirement • March 27, 2012

Roth IRA

It’s easy for young adults to get carried away with prospects of starting a career or growing a family in their 20s. However, a major oversight young people make is underestimating how important their youth is when planning for retirement.

With over 35 percent of people over the age of 65 relying on limited Social Security reserves, young professionals should take advantage of their early paycheck-earning years by opening a Roth IRA. The uncertainty of the U.S. Social Security program presents an increasing need for alternative retirement solutions, like a Roth IRA, to comfortably fund those golden years down the road.

According to the 2012 Retirement Confidence Survey, a staggering 30 percent of American Workers have less than $1,000 in retirement savings and investments. What’s more concerning is that of the individuals surveyed, 35 percent felt that they would need at least $500,000 by the time they retire in order to live comfortably.

Saving half a million dollars is no simple feat, especially with the potential debt from mortgages, college expenses and credit cards weighing down on many young Americans. However, capitalizing on younger years — particularly between the ages of 20-30 — with a Roth IRA can make that $500,000 retirement savings figure much more attainable.

Best Savings Account for Young Adults

The best savings account for young adults isn’t a basic savings account like those provided by banks in tandem with a checking account. Roth IRAs provide years of benefits with relatively simple conditions to adhere to compared to other investment options, making them an overwhelming favorite among most young professionals.

How a Roth IRA Works

Roth IRAs are one of the best investments for young people, because of how they are taxed. This type of IRA requires depositors to pay income tax based on their existing tax bracket, and contributions made to a Roth IRA go in post-tax. That means when the account holder reaches retirement age, withdrawals (including earned interest) are made tax-free.

Typically, young professionals receive their lowest salaries at the start of their careers, and therefore, fall within a lower tax bracket, as opposed to the higher tax bracket they are placed in as senior-level professionals later in their careers.

With this in mind, Roth IRAs require young adults to pay taxes now — at a lower tax bracket — instead of paying taxes upon withdrawal at a potentially higher tax rate, as with traditional IRAs. New Gen Y professionals, in turn, hold onto more of their retirement savings when it matters most.

Additional advantages of a Roth IRA include:

  • Tax-exempt withdrawals at retirement age (age 59.5)
  • No mandatory distribution age (i.e. if you don’t want to withdraw at retirement, you don’t have to)
  • Freedom to invest in other investment types like 401(k), stocks, bonds, CDs, etc.
  • The principal can be withdrawn at any time without penalty

As a young adult, there are many factors in life that remain uncertain and the flexibility of a Roth IRA in terms of withdrawals, penalties and diversification are welcomed benefits.

Roth IRA Contribution Limits and Requirements

While a Roth IRA is among the best investments for young people, it is not without its faults. One disadvantage of this retirement savings account is that there are limitations as to who is eligible to open a Roth IRA.

This retirement option is only available to young adults who meet certain income requirements. For 2012, single individuals must make a maximum annual income of $110,000 and married couples must fall below a combined annual income of $173,000.

Further, depositors must be employed in order to deposit into a Roth IRA. For example, left-over birthday gift money or extra student loan awards may not be deposited into a Roth.

Roth IRA contribution limits determine the maximum amount depositors can contribute to their IRA annually. For young professionals who meet the standard adjusted gross income (AGI) requirements, the contribution limits are typically $5,000, regardless of marital status. Depending on annual income, however, Roth IRA contribution limits may be gradually reduced if your AGI exceeds the maximum amounts described above.

The Roth IRA Movement

Encouraging young adults to take serious strides in securing their retirement via a Roth IRA is a movement that is quickly picking up pace. Jeff Rose of Good Financial Cents is an advocate of Roth IRAs for young professionals and has joined forces with over 140 bloggers, companies and financial websites to educate Gen Y of the virtues of a Roth IRA.

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