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It’s really unfortunate that our high schools and colleges spend so much time and effort educating our children about math, English and science, but don’t give them any tools to navigate the real world. Oh sure, you can take “life skills” or something similar in high school, but that’s not a “college prep” class, and it doesn’t really do what I’m talking about, anyway.
What our young people need to learn is how to manage their money, how to pay off any debt they have accumulated, how to invest for their future. Many come from backgrounds where their parents don’t have these skills, and so they don’t even know what they are missing.
In 2012, financial expert Jeff Rose discovered this for himself, when making a presentation to a group of soon-to-be-graduating college seniors. They barely knew what an IRA was, had never heard of a Roth IRA, and had no idea just how important this one concept could be for them.
Rose has started what he calls a “movement,” in which he wants to ensure that all young people know what a Roth IRA is and how it can help them. His goal is to “give young people the knowledge, the motivation, and the urgency of why they need to not only know about the Roth IRA but to also learn the benefits of investing now.”
Most people know something about IRAs, or what are called Traditional IRAs. You set aside money for your retirement, up to a particular annual limit, and you can deduct this amount from your taxable income when you file your taxes. Then you let it grow until you retire, and you can’t access it before you reach a certain age or you get hit with huge penalties. And eventually the government makes you take RMDs (Required Minimum Withdrawals) because they want to get the tax revenue that you deferred earlier in your working career.
A Roth IRA is also a retirement savings account, but because of its nature, it can be used for so much more. First of all, you don’t get a tax break when you put money into a Roth, so you don’t need to report it on your taxes. Therefore, instead of taking a few hundred dollars in tax deductions now, you will forgo that for the much better tax break that comes later.
Here’s the twist: When you withdraw the gains in retirement, every penny can be withdrawn tax-free. Absolutely, positively, no taxes. So if you put in $5000 every year while you are in your twenties, and that money grows to millions of dollars by the time you retire, you will owe zero tax on that gain.
It’s hard to believe that our government actually gives us such a generous gift. And it’s hard to understand why more people don’t know about it and take advantage of it.
You can actually withdraw your contributions at any time. Not so the earnings, but the contributions. So if you have an account with $10,000 in contributions and $2000 in earnings, you can actually withdraw the $10,000 at any time, with no problem. In this way, a Roth IRA can be a great way to save for a mid-term goal, like a downpayment on a house, while also generating a retirement portfolio at the same time.
You also don’t have to make any mandatory withdrawals on that money, either. Unlike with a regular IRA or 401(k), where the IRS has not yet received its due, you’ve already paid your taxes on your Roth contributions, and the government has no further claim to the money. You don’t even have to tell the IRS what it’s worth.
And because of no mandatory withdrawals, you don’t have to draw it down at all, if you don’t want to. If you don’t need to spend it, you can leave it all to your heirs. And they may not owe any taxes on it, either, when they withdraw it. (There are some complicated rules for heirs, but I wont go into that here.)
So the biggest advantage come the earlier you can get started, and the more frequently you can invest (up to the $5000 per year limit – the government is generous, but not stupid!)
This is the best gift the government has ever devised for investors. It’s better than the 15% tax rate on capital gains and dividends. It’s better than investing your pre-tax money in a traditional IRA. In fact, the only thing that is better is the company match on your 401(k) contributions.
So the smartest way to invest for retirement is to first, max out your company match if you are offered a 401(k). Secondly, put any additional savings into a Roth IRA. And thirdly, if you have even more money that you want to save, put it into a traditional IRA.
Imagine, having a huge nest egg when you retire, on which you won’t have to pay a single penny in income taxes. If that isn’t motivation, I don’t know what is.